Excel errors and a new Simpson-Bowles report

Better double-check your Excel spreadsheets. This week, two Harvard economists, Ken Rogoff and Carmen Reinhart, admitted they had made a mistake in the Microsoft Excel spreadsheet they used in their report on GDP and growth.

The original report said that when a country owes more than 90 percent of their GDP, it slides into recession. It had been used in budget policy decisions in the U.S. as a reason for reducing government spending.

The economists responded by saying that other studies support the overall research and results. Could this change the U.S.’s budget policies in the future?

“Look, debt is still a problem. I don’t think anybody would disagree with that,” said Fortune magazine’s Leigh Gallagher. “You can see the ‘Saturday Night Live’ skit being written…you have to note the irony. It’s like when I go to my hairdresser — I don’t know how to do what he does, but I do expect him to cut it evenly, you know?”

“It’s actually even more basic than that,” Reuters’ Felix Salmon countered. “If you can’t literally just add up a row of numbers in an Excel spreadsheet? And the other thing is that people really took this 90 percent number to heart.

“If there’s one thing that everyone in the world knows about Reinhart and Rogoff, it’s that 90 percent is really dangerous; after this level you go into this kind of red zone. And it turns out, even if things become worse, gradually, slowly as you get more debt, there’s nothing special about 90 percent.”

Listen to the full audio for additional analysis and more on the new Simpson-Bowles deficit reduction plan.

#Longreads

The Wrappers offer their weekend #longreads picks.

Felix Salmon suggests:

• Christopher Maag on acoustic engineering in the NYC subway.


• Felix Gilette in Bloomberg on the latest resurgence of Rupert Murdoch.


• The New Republic’s Jonathan Cohn on the hell of American daycare.

Leigh Gallagher picks:

• Jessi Hempel on the second coming of Facebook.


• Brian Dumane on the arrival of fracking in China.


• And Luke Cyphers at SBNation considers a world without college sports.

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Excel errors and a new Simpson-Bowles report

Excel Spreadsheets, Krugman, and a Question of Logic

In 2010 paper Growth in a Time of Debt and again in a book entitled This Time is Different, Harvard economists Ken Rogoff and Carmen Reinhart presented the idea that when a country’s ratio of debt to gross domestic product reaches 90% lower economic growth is on the horizon.

However, Rogoff and Reinhart made an Excel Spreadsheet Error in their work that has the economic world in a tizzy.

A new study by three researchers at the University of Massachusetts finds that Rogoff and Reinhart made several mistakes that invalidate their thesis. They made a spreadsheet error that resulted in their leaving five countries out of an all-important average of countries with higher than 90% debt-to-GDP ratios. By restoring the full average, the UMass authors say, the growth rate for countries in that range becomes 2.2%, not the -0.1% cited by Rogoff and Reinhart. That makes the average growth rate at that ratio “not dramatically different than when debt/GDP ratios are lower.”

One irony of the finding stems from the fact that the debt-to-GDP ratio always was something of a heffalump. As economist Robert Shiller pointed out in 2011, yoking the two statistics together doesn’t necessarily tell you anything useful. Debt is measured in currency, he observed; GDP is measured in currency units per year. But there’s “nothing special about using a year…. A year is the time that it takes for the Earth to orbit the sun, which, except for seasonal industries like agriculture, has no particular economic significance.”

Error Austerity Debate

CNBC picked up the story in Reinhart-Rogoff Error Sparks Austerity Debate.

Adding fuel to to an already contentious debate over whether tough austerity measures are helpful or harmful to an economy, is a new revelation that there was a mathematical error in an influential economic research study, often cited as having paved the way for fiscal policies pursued by the U.S. and Europe.

The charge was raised in a paper, released Tuesday, by an economics doctoral student and two professors at the University of Massachusetts that called into question the findings of Harvard economists Carmen Reinhart and Kenneth Rogoff’s 2010 paper “Growth in a Time of Debt,” which concluded debt over a certain level was dangerous for countries.

Reinhart and Rogoff said they made a bad calculation within an influential economic research paper in 2010, but rebut claims that the errors were made intentionally. They also stand behind the central theme of the paper that too much public debt will slow economic growth.

Krugman Chimes In

Paul Krugman chimed in with his response Reinhart-Rogoff, Continued.

I was going to post something sort of kind of defending Reinhart-Rogoff in the wake of the new revelations — not their results, which I never believed, nor their failure to carefully test their results for robustness, but rather their motives. But their response to the new critique is really, really bad. ….

The Obvious

Let’s step back from the politics of the debate to focus on the obvious. My friend Pater Tenebrarum on the Acting Man Blog sent this common sense analysis of the setup in an email.

Empirical studies cannot be used to settle points about economic theory. It should be obvious that deficit spending is nothing but deferred taxation. And obviously, since government spending has no concept of the categories of profit and loss, such spending is typically a mindless waste of scarce resources. No bureaucracy has any inkling of opportunity costs or consumer wishes. The spenders are saying: government bureaucrats know better how to allocate resources than the private sector. Perhaps, but certainly not in this universe.

GDP Definition

I remind readers that by definition, government spending adds to GDP.  The government can pay people to spit at the moon or dig ditches and fill them back up again and those activities will add to GDP.

Does such economic stupidity matter at 90%, 95%, or 130% of GDP?
Is it even relevant?

What does matter is the obvious. And it should be obvious that wasting money to stimulate the economy is just that: waste.

The trigger point as to when such waste matters most likely varies country to country based on factors that no excel spreadsheet can properly discern in advance.

Rogoff and Reinhart made an error. So did Krugman. At least Rogoff and Reinhart have the general idea correct: economic stupidity matters at some point, something Krugman cannot seem to grasp.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Mike “Mish” Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Mish’s Global Economic Trend Analysis

Excel Spreadsheets, Krugman, and a Question of Logic

The Excel mistake heard round the world

In the last three years, there has been a concerted effort by those in Washington to reduce government spending and reign in the national debt. One reason for the budget cuts? Research by two Harvard economists, Ken Rogoff and Carmen Reinhart. The pair found that when a country owes more than 90 percent of their GDP, it slides into recession.

Except Reinhart and Rogoff made a glaring mistake in the Microsoft Excel spreadsheet they used to calculate their averages. “They left off five countries. And that changed things pretty significantly,” says Tim Fernholz, a business reporter with Quartz. Instead of a mild recession, carrying that much debt means a country is probably going to have mild growth — slow, but growth all the same.

The Reinhart-Rogoff spreadsheet, via qz.com

But why did this one paper have such huge implications on budget policy? When a country is faced with recession, it has two choices — stimulus, or austerity. Pump more money into your government, grow your debt, and hope that you’re creating enough jobs along the way to work your way out of the slump. Or you can start making cuts to slow the amount of money your country will need to borrow. “In the long term, economists think that having less debt is going to be better for the economy. But if you’re coming out of a crisis, you have to make a decision then and there.”

And this was especially true with Reinhart and Rogoff’s paper. The pair met with 40 senators in 2011 and “they told them, you need to act now and that we can’t afford to spend more money to stimulate the economy.” Also reading research by the two Harvard economists were budget chairs from both parties, then Treasury Secretary Timothy Geithner, the Simpson-Bowles Commission and financial leaders in countries overseas. “When we were talking about the budget deficit and the debt in 2010, 2011 and 2012, everybody had this 90 percent threshold on their minds,” says Fernholz.

In their defense, Reinhart and Rogoff point to other studies that show high debt leads to slow growth. But Fernholz says “it’s not clear if countries that are growing slowly have high debt or if high debt causes countries to grow slowly.” The Reinhart-Rogoff research suggested causation instead of correlation.

“When politicians around the country and in fact around the world were deciding what to do to save the economy after the recession, they were reading this paper and it was scaring them,” says Fernholz. “And it was making them think, we need to cut the debt now if we want to save the economy.”

This was true, for example in the United Kingdom which quickly implemented austerity measures. The country’s economy is in bad shape today. Meanwhile, in the U.S., there was a stimulus and Congress moved slower to make budget cuts. And while the economy here isn’t exactly sparkling, both debt and unemployment are going down.

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The Excel mistake heard round the world