By Carmen M. Reinhart Kenneth Rogoff co-authors of the spectacular, and best selling book This Time Is Different: Eight Centuries of Financial Folly
With the advanced economies at a critical juncture, some economists are urging more fiscal stimulus while others argue that raising debt levels will stunt growth. This column presents the Reinhart-Rogoff findings on the relationship between debt and growth based on data from 44 countries over 200 years with a focus on the debt-growth link during high-debt episodes.
Economics has been under fire since the recent crisis for enshrining abstract models that offer little connection to the real world. In “Growth in a Time of Debt,” our data-intensive approach aims at providing stylised facts, well beyond selective anecdotal evidence, on the contemporaneous link between debt, growth, and inflation at a time in which the world wealthiest economies are confronting a peacetime surge in public debt not seen since the Great Depression of 1930s and indeed virtually never in peacetime. As Paul Krugman (2009) observed, “they’ll (the economists) have to do their best to incorporate the realities of finance into macroeconomics.” One might add as a corollary, however, that such discipline is especially needed when those realities are inconvenient to strongly held opinions.
And you don’t have to look far these days to find such strong opinions about the fork-in-the-road facing advanced economies when it comes to debt. There is no shortage of recommendations for either path, see, for example, the Vox columns by Calvo (2010), Corsetti (2010), and Giavazzi (2010) last month.
In a recent paper, we studied economic growth and inflation at different levels of government and external debt (Reinhart and Rogoff 2010a). The public discussion of our empirical strategy and results has been somewhat muddled. Here, we attempt to clarify matters, particularly with respect to sample coverage (our evidence encompasses 44 countries over two centuries – not just the US), debt-growth causality (our book emphasises the bi-directional nature of the relationship), as well as nonlinearities in the debt-growth connection and thresholds evident in the data. These are fundamental points that seem to have been lost in some of the commentary.
In addition to clarifying the earlier results, this column enriches our original analysis by providing further discussion of the high-debt (over 90% of GDP) episodes and their incidence. Some of the implications of our analysis, including for the US, are taken up in the final section.
We begin by reiterating some of the main results of Reinhart and Rogoff (2010a).
The basic exercise and key results
Our analysis was based on newly compiled data on forty-four countries spanning about two hundred years. This amounts to 3,700 annual observations and covers a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances.
The main findings of that study are:
- First, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below 90% of GDP.1 Above the threshold of 90%, median growth rates fall by 1%, and average growth falls considerably more. The threshold for public debt is similar in advanced and emerging economies and applies for both the post World War II period and as far back as the data permit (often well into the 1800s).
- Second, emerging markets face lower thresholds for total external debt (public and private) – which is usually denominated in a foreign currency. When total external debt reaches 60% of GDP, annual growth declines about 2%; for higher levels, growth rates are roughly cut in half.
- Third, there is no apparent contemporaneous link between inflation and public debt levels for the advanced countries as a group (some countries, such as the US, have experienced higher inflation when debt/GDP is high). The story is entirely different for emerging markets, where inflation rises sharply as debt increases.
Figure 1 summarises our main conclusions as they apply to the 20 advanced countries in our 44-country sample. We will concentrate here on the advanced countries, as that is where much of the public debate is centred.2
In the figure, the annual observations are grouped into four categories, according to the ratio of debt-to GDP during that particular year. Specifically years when debt-to-GDP levels were:
- below 30 percent;
- 30 to 60 percent;
- 60 to 90 percent; and
- above 90%.3
The bars show average and median GDP growth for each of the four debt categories. Note that of the 1,186 annual observations, there are a significant number in each category, including 96 above 90%. (Recent observations in that top bracket come from Belgium, Greece, Italy, and Japan.)
From the figure, it is evident that there is no obvious link between debt and growth until public debt exceeds the 90%threshold. The observations with debt to GDP over 90% have median growth roughly 1% lower than the lower debt burden groups and mean levels of growth almost 4% lower. (Using lagged debt does not dramatically change the picture.) The line in Figure 1 plots the median inflation for the different debt groupings – which makes clear that there is no apparent pattern of simultaneous rising inflation and debt.
Figure 1. Government debt, growth, and inflation: Selected advanced economies, 1946-2009
Notes: Central government debt includes domestic and external public debts. The 20 advanced economies included are Australia. Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, the UK, and the US. The number of observations for the four debt groups are: 443 for debt/GDP below 30%; 442 for debt/GDP 30 to 60%; 199 observations for debt/GDP 60 to 90%; and 96 for debt/GDP above 90%. There are 1,180 observations. Sources: Reinhart and Rogoff (2010a) and sources cited therein.
High-debt episodes in the sample
The episodes that attract our interest are those where debt levels were historically high. As convenient as it is to focus exclusively on a particular country or a single episode for a single country (like the US around World War II, where the data is readily available, or an interesting ongoing case, like Japan), the basis for an empirical regularity is multiple observations. Because our data span 44 countries with many going back to the 1800s or (at least the beginning of the 19th century), our analysis is based on all the episodes of high (above 90%) debt for the post World War II period; for the pre-war sample it covers all those that are encompassed by the availability of data. Table 1 (from Reinhart and Rogoff 2010a) describes the coverage and the basic statistics for the various debt levels for the advanced economies.4
It is common knowledge that the US emerged after World War II with a very high debt level. But this also held for Australia, Canada, and most markedly the UK, where public/debt GDP peaked at near 240%