What's that Excel error that everyone is talking about?
Two renowned economists, Kenneth Rogoff and Carmen Reinhart, published a research paper in 2010 where they explored the correlation between countries’ amount of debt and growth. They concluded that when a country's debt exceeds 90% of the GDP the countries with such a ratio are more likely to suffer from lower growth. The paper would not be a big deal if their findings were arithmetically robus or their findings were not adopted by governments around the world as a blueprint for their post-crisis economic policies. Alas, it's a big deal. Many policymakers in the U.S. and in Europe jumped on these conclusions and used them to conduct the policy of austerity.
As it turns out, Rogoff/Reinhart didn’t do their due diligence and used some flawed logic. A graduate student at UMass and two of his professors checked Rogoff/Reinhart’s own data and found some major inconsistencies. First, the Excel spreadsheet summary cell that calculated the average for "over 90% debt to GDP" didn’t count all data in that column, meaning some crucial data was omitted, thus bringing the average to -0.1 where the actual number should have been 2.2%. Rogoff and Reinhart admitted this mistake. Second, even if they made the correct calculations, how could they arrive to the conclusion that higher debt leads to higher GDP but not the other way around? Correlation is not the same as causation.
But let's not dwell on their mistakes, however tempting this might be: whether or not Rogoff/Reinhart manipulated the data (as someone who spent a career in front of Excel spreadsheets I’m aware of possibilities for an honest mistake), what's stunning here is how much weight their paper alone received in political circles here and in Europe. The fate of millions of people was affected, mostly for the worse, because politicians chose to base their decisions on what two persons with fancy titles and a lack of attention to detail wrote. Unfortunately, economics, unlike physics, is not an exact science, but a matter of competing schools of thoughts. It's up to politicians' personal preferences what economists they choose to listen to. We just go along for the ride, whether we like it or not.
So deficit hawks around the world got their excuse to proceed with austerity. Austerity (the policy of cutting spending) has been a de rigueur policy around Europe (excluding Iceland, which followed a different path and has long since recovered). It was especially rigorously applied in Greece, Spain and Ireland. This harsh medicine of austerity has been applied to those poor patients for at least 3 years with no positive results — those countries still have high unemployment and no growth. The U.S. almost went this way, as we have plenty of voices (mostly conservative or libertarian) who subscribe to the idea of cutting spending in tough times. Still, the U.S. was largely able to avoid Europe’s fate as we managed to pass the much-hated stimulus in 2009 that consisted partially of tax cuts and partially of social spending. It's hard to make an argument "it would have been much worse without it" because there’s no data to measure what could have been, unless you look at Europe.
The issue of debt is not entirely black and white. Debt is like fire — if one is careful, it can be harnessed to make our lives easier, but it also can get out of control and destroy everything in its path. Our employment market is cold. It needs large spending projects, which in past decades have been routinely financed through debt; our banking industry is overheating (as their entire business model rests on the amount of debt) and needs deleveraging (fancy word they use to describe paying off debts).
What we have now is a barbelled scenario where one side is required to tighten their belts under the auspices of "living within their means" (average citizens) and the other side of the barbell is being showered with cheap debt (banks). Those two side and the remedies they're being prescribed should be reversed. Main Street needs jobs and cash; Wall Street needs to revise its business model to focus on providing useful services rather than gambling with borrowed money.
In some weird way, I'm glad that such an egregious mistake occurred: it exposed how fallible our experts are and how vulnerable our entire economic policies to a routine human error. But I'm also skeptical about whether deficit hawks, here or in Europe, are capable of being moved by empirical evidence they don't like.