The ECB sticks to the discredited 90%-debt-threshold-story with pathetic new evidence
from Norbert Häring
If you read the May Monthly Bulletin of the European Central Bank, you could be forgiven for thinking that the ECB has simply missed the widely publicized April debate around the mistakes Carmen Reinhart and Ken Rogoff made in the data analysis which formed the basis for the 90%-debt-level-threshold story. That story says that if the public debt to gdp ratio starts to exceed 90% growth goes down markedly. The ECB writes on page 95:
“Empirical literature has increasingly shown that high levels of debt (both public and private) are detrimental to growth. Some of these studies derive implicit thresholds for debt ratios and find that, beyond a certain level of debt which is maintained for a number of years, there is evidence that GDP growth remains subdued. While there is significant uncertainty surrounding such threshold estimates, there appears to be some empirical evidence that, on average, levels of public or private sector debt above 90% of GDP impair an economy’s growth.11”
However, if you follow footnote 11 you find that the Reinhart-Rogoff-paper, which had been center stage in a similar article in the March Monthly Bulletin is not mentioned any more. The main source for the public-debt-part of the story now is a paper by the two ECB economists Crisitina Checherita-Westphal and Philipp Rother.
If you actually read this paper, you are in for a surprise. The two authors come to the conclusion that up to a debt to gdp ration of about 100% average growth is actually increasing. Only if you go above 100% is it decreasing again. The graphs presented in the working paper version (Graph 1, page 33) imply that at a debt level of 140% growth is still above the level that you could expect at a 60% debt ratio.
This is pretty tough stuff for an institution like the ECB to promote. Most countries in the Euro Area would have to raise their level of public debt if they wanted to promote growth and believed in the results of this study.
However, the ECB does not hesitate to draw the opposite conclusion, probably trusting that hardly anybody reads the footnotes and nobody actually reads the papers mentioned there. The well-established growth diminishing effects of high government debt, they say, implies that a reduction in debt should increase growth. They forget to mention, that according to the study they cite as evidence, this is only true at debt levels above 100%.
It is not hard to understand why the ECB is going to such lengths of manipulation and misrepresentation to defend a discredited theory. It is the main theoretical justification for the austerity policies that are currently imposed on Europe. As this policy has already pushed much of Southern Europe into depression and the rest of the Euro Area into recession, policy makers can ill afford to let the promise of a brighter future as payoff for short term pain go down the drain.
To top the whole thing off: a very recent literature survey by Ugo Panizza and Andrea Presbitero yields the following result:
“We find that theoretical models yield ambiguous results. Whether high levels of public debt have a negative effect on long-run growth is thus an empirical question. While many papers have found a negative correlation between debt and growth, our reading of the empirical literature is that there is no paper that can make a strong case for a causal relationship going from debt to economic growth. We also find that the presence of thresholds and, more in general, of a non-monotone relationship between debt and growth is not robust to small changes in data coverage and empirical techniques. We conclude with a discussion of the challenges involved in measuring and defining public debt and some suggestions for future research which, in our view, should emphasize cross-country heterogeneity.”