BRUSSELS – After being accused of miscalculating the fiscal multipliers in the implementation of austerity measures in countries including Greece, the European Commission’s Directorate General for Economic and Financial Affairs (DG ECFIN) is once again on the defensive over an econometric issue. Critics argue that the theoretical basis for implementing harsh austerity measures across the board in the eurozone – a paper published in 2010 by economists Carmen Reinhart and Kenneth Rogoff called “Growth in a Time of Debt” – has now been shattered, since it was proven that its “math was wrong.” But, just like in the case of the fiscal multipliers quarrel, the DG ECFIN seems determined to fight back. EU Commission vice president responsible for Economic and Financial Affairs, Olli Rehn, told Kathimerini that “we have cited this study in the past as illustrative, but let’s be clear that we do not design our policies on the basis of any single piece of research” and insisted that “structural reforms, financial sector repair, and consistent fiscal consolidation” are equally important parameters for ensuring sustainable economic growth.
The authors of the contentious 2010 paper claimed that comparative historical data from the study of advanced economies lead to the conclusion that when public debt levels exceed 90 percent of gross domestic product, then growth falls sharply to borderline recessionary levels. This seemingly conclusive argument provided the rationale for adopting strict deflationary measures, not “for the sake of austerity itself,” but because high debt meant low growth, and, in turn, low growth meant high unemployment and social tensions. Indeed, Vice President Rehn had repeatedly referred to “serious economic research,” which pointed out that when debt levels rise above 90 percent of GDP, they hamper growth. In an interview published in Kathimerini English Edition last November, Rehn had said, “We must also continue with smart consolidation, which means avoiding excessive indebtedness because we have already overstepped in Europe at a level of around 90 percent, which has a very negative impact on economic activity.”
However, according to a paper just published by economists Robert Pollin and Michael Ash, the widely quoted and immensely influential Reinhart and Rogoff research was based on “a series of data errors,” “unsupportable statistical techniques” and “straightforward miscalculation” (Financial Times, April 17). In fact, even the two authors of the 2010 study now acknowledge that there were “Excel coding errors” in their paper (!).
Faced with a series of aggressive journalists’ questions in the last two days, Commission spokespersons have been arguing that the DG ECFIN’s policy was not based on just one paper, since “that would be ridiculous.” Nonetheless, just as was the case with the fiscal multipliers debate, the econometrical blunder has been elevated into a political issue. As Daniel Shuchman wrote in Forbes magazine, “the New York Times, Financial Times and other publications contend that R&R’s paper is the intellectual foundation of the arguments for spending austerity and debt reduction in the developed world. They note that policymakers such as Rep. Paul Ryan and Olli Rehn of the European Commission, among many others, have approvingly cited ‘Growth in a Time of Debt’ in arguing for fiscal discipline. It is alleged that the debunking of the paper’s methodology undermines the case for spending restraint and fiscal reform in advanced economies.”
Asked by Kathimerini to comment on the new accusations made against him, Rehn said that “we have cited this study in the past as illustrative, but let’s be clear that we do not design our policies on the basis of any single piece of research. We design our policies on the basis of a holistic assessment drawing on a wealth of studies – but also of course on our own analyses.” Moreover, Rehn defended the fiscal consolidation “at an appropriate pace for each different country case,” arguing that “the crisis that many European countries are experiencing is driven by an adjustment in balance sheets, after an unsustainable buildup of debt, sometimes private debt, sometimes public debt, sometimes both. There is no silver bullet and no single solution for all countries, but it is clear that we will only have sustainable growth if it is built on the solid foundations of sound public finances.”
What is certain is that no matter how convincingly Rehn makes his case for fiscal restraint, his critics, including his academic “archenemy,” Paul Krugman of The New York Times, just acquired a new weapon for their arsenal. Rehn’s political position will be further weakened. And critical supporters of his views will keep wondering why he personally accepts exclusive responsibility for the austerity measures implemented in Europe, when EU insiders know that it is Germany, and not Brussels, which has the “wallet” and hence calls the shots. Strangely enough, though, it is Rehn who has found himself in the line of fire of Keynesians. In the meantime, Wolfgang Schäuble, the German finance minister, can comfortably enjoy the debate from the safe distance of Berlin.