The discovery of errors in the Reinhart-Rogoff paper on the growth-debt nexus is already impacting policy. A participant in last Friday’s G20 meetings told me that the error was a factor in the decision to omit specific deficit or debt-to-GDP targets in the G20 communique. It’s also a new talking point in the battle over the budget—offered as a reason why the U.S. should stop worrying about budget reform and consolidation and start worrying about austerity.
But the main arguments now for controlling the growth of spending and gradually bringing the U.S federal budget into balance overpower any one study, right or wrong. First, under current budget policy the debt to GDP ratio will grow at such an explosive rate in the future that, if allowed to continue, will cause economic damage according to virtually any study. Recall that the CBO projects that under current law the federal debt held by the public will be rising to 250% in 30 years. Even this is an underestimate if interest rates rise faster than assumed by CBO. If CBO went out further in time, as they used to, the debt ratio goes over 700%.
Second, the claims about austerity in the current budget proposals are exaggerated. Consider the recent House budget proposal which balances the budget in 10 years without raising taxes by gradually reducing the growth of spending. It would reduce federal outlays as a share of GDP by 3.1 percentage points over the next decade (from 22.2% in 2013 to 19.1% in 2023). Critics label it austere, but this is less spending restraint than the 4.1 percentage point reduction in outlays as a share of during the 1990s (when spending fell from 22.3% in 1991 to 18.2 % in 2000). With this spending restraint, the 1990s were a very good decade for economic stability and growth, and they left the budget in balance. The same can be said for the next decade. The benefits of properly addressing the debt and deficit problems are enormous and the costs are surprising small.