Growth in a Time of Debt

A 2010 NBER working paper by Reinhart and Rogoff (also published in AER P&P) claimed that countries grow slower when they have high public debt to GDP ratios. Frank Jotzo pointed me to a blog which shows that there seem that the result is heavily influenced by a single year of -7.9% growth in New Zealand when the debt/GDP ratio was above 90% and there are also mistakes in the analysis. These issues are described in this new working paper. Without the New Zealand data point and correcting the mistake, the average growth rate in the 7 countries with debt ratios above 90% is 1.4% and with NZ is 0.3%. Still that is lower than the growth rate at the lower debt ratios and the highest growth rate is at the lowest debt ratio. Still, the negative correlation between debt to GDP ratio and growth rate does look real. But what is needed is probably a fixed effects regression of annual growth rates data on debt ratios or something like that. Also, Figure 2 in Reinhart and Rogoff presents medians as well as means of growth rates, which is more robust way of dealing with this data:

Table 1 in Reinhart and Rogoff shows data from a longer period and NZ now has positive growth at high debt ratios. Here the relationship looks more fragile though still hanging on. They also present similar data for developing countries where the relationship seems to be present too. So, while there are clearly problems with this paper I think the blog linked above is overly negative on the results. Reinhart and Rogoff have also responded to this criticism.

The real question though is about causality. Does high debt cause slow growth or vice versa?