There are errors and errors. Does the Reinhardt and Rogoff miscalculation mean that Osborne should change tack?

The distinguished American academic economists, Carmen Reinhardt and Ken Rogoff, have been very much in the news. Their 2009 book, This Time is Different, was a comprehensive examination of financial crises over the past 800 years. The work received many plaudits and awards. They suggested that when the ratio of public debt to GDP in a country rose above the 90-100 per cent range, the chances of a financial crisis increased sharply. And the consequence was that economic growth in the country would be adversely affected.

The finding has been queried by a trio of fellow Americans. Reinhardt and Rogoff do seem to have conceded that their own calculations contain a glitch. The new analysis has been seized on by opponents of austerity policies. But how much does it matter that an error was made? At the moment, the debt to GDP ratio in the UK is just below the crucial level of 90 per cent. Does this miscalculation mean that George Osborne should change tack and spend to try and stimulate the economy?

In defence of Reinhardt and Rogoff, they never elevated their suggestion into a ‘theorem’ or a ‘law’. They simply suggested that high levels of public debt tend to be a Bad Thing. Even the most devoted Brownite would surely accept that there is some limit to how much public debt can be incurred relative to the size of the economy. The real question is: what is this limit?

A great deal depends upon the extent to which an increase in debt leads to higher interest rates. More public expenditure financed by issuing long-dated gilts at around the current yield of 2 per cent is one thing. But if it causes gilt yields to rise to, say, 4 per cent, it is pretty disastrous.

Higher interest rates would have an adverse effect on business confidence. If rates doubled, the capital value of the outstanding stock of gilts held by the private sector would fall by 50 per cent – a severe negative shock to the wealth of the sector. And higher taxes will at some point be needed to meet the higher interest payments.

There is a lot of evidence to suggest that high public debt levels relative to GDP are indeed associated with higher interest rates. The Mediterranean economies are just the latest example of this. But there is no automatic connection between debt and rates. The relationships which are coaxed out of the data are not like the laws of physics.

So much depends upon psychology. Osborne pushing up debt by cutting taxes might be one thing. Balls doing the same by hiring more bureaucrats might be perceived quite differently. But at some point, regardless of who the Chancellor might be, an increase in public debt would have an adverse impact on the economy. The theoretical channels by which this happens are well understood.  And an ounce of good theory is worth a ton of applied econometrics.

Paul Ormerod

As published in City AM on Wednesday 24th April

Watch Paul present this argument on Newsnight in debate with Nobel prize winner Joseph Stiglitz (feature from 23:30)

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Alex O’Byrne, Associate at Volterra, is an experienced economic consultant specialising in economic, health and social impact, economic strategy, project appraisal and socio-economic planning matters.

Alex has led the socio-economic and health assessments of some of the most high profile developments across the UK, including Battersea Power Station, Olympia London, London Resort, MSG Sphere and Westfield. He has significant experience inputting to EIAs and s106 discussions as well as drafting economic statements, employment and skills strategies and affordable workspace strategies.

Alex is also experienced at economic appraisal for infrastructure. He was project manager of the economic appraisal for the City Centre to Mangere Light Rail in Auckland. He also led the economic and financial appraisals of the third tranche of the Transport Access Program for Transport for New South Wales, in which Alex developed and employed innovative methodological approaches to better capture benefits for individuals with reduced mobility.

He is interested in the limitations of current appraisal methodologies and ways of improving economic and health analysis to ensure it is accessible to as many people as possible. To this end, Alex recognises the importance of transparent and simple to understand analysis and ensuring all work is supported by a robust narrative.

Alex holds a BSc (Hons) in Economics from the University of Manchester and he was a member of the first cohort of the Mayor’s Infrastructure Young Professionals Panel.


Senior Partner

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Ellie is a partner at Volterra, specialising in the economic impact of developments and proposals, and manages many of the company’s projects on economic impact, regeneration, transport and development.

With thirteen years experience at Volterra delivering high quality projects to clients across the public and private sector, Ellie has expertise in developing methods of estimating economic impact where complex issues exist with regards to deadweight, displacement and additionality.

Ellie has significant experience in estimating the economic impact across all types of property development including residential, leisure, office and mixed use schemes.

Project management of recent high profile schemes include the luxury hotel London Peninsula, Battersea Power Station and the Nova scheme at London Victoria. Ellie has also led studies across the country estimating the economic and regeneration impact of proposed transport investments, including studies on HS2 and Crossrail.

Ellie holds a degree in Mathematics and Economics from the University of Cambridge.