Does High National Debt Cause Slow Economic Growth?

Reinhart and Rogoff tried to answer that question by looking at historical data.  They found a correlation between national debt and slow economic growth.  They concluded that high national debt caused low economic growth.  They also concluded that growth was particularly constrained when national debt reached 90% of GDP.  Deficit hawks loved this result.  Pundits and conservative  politicians argued that it was imperative to prevent national debt from reaching the 90% threshold established by R&R.

One of the problems with their conclusion is that correlations do not determine the direction of causation.  It is quite possible that low economic growth causes high national debt.  Nevertheless, the conclusions from the R&R study were widely accepted.  A new law in economics had been established.  National debt exceeding 90% of GDP would lead to low economic growth.

A new study found many several mathematical and methodological problems in the R&R data.  It showed that the impact of national debt on economic growth was much lower than that reported by R&R.  It also raised questions about the direction of causality.  R&R admitted some of the errors in their study but they defended their conclusions in an article published by the Wall Street Journal. Paul Krugman criticizes their defense in this article, and he tests the direction of causality by plotting the data by country.  He found that the relationship between national debt and economic growth was primarily determined by the correlation between debt and low growth in Japan and Italy.  It is well understood that economic growth in each of these countries has been affected by powerful factors other than national debt.  Low population growth and demographics in both of these countries is having a large impact on economic growth.  It is more likely that rising national debt has been caused by low economic growth in Japan and Italy.

Economists will be debating the validity of these studies on the relationship between economic growth and national debt for some time.  Unfortunately, this is not simply an academic question.  The R&R study was used to defend austerity programs in Europe and the US.  Politicians used the R&R study to conclude that reducing government debt would produce economic growth.  The R&R study encouraged the belief in expansionary contraction.  The damage has already been done.