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April 23, 2013

'Austerity Loses an Article of Faith'

Martin Wolf:
In 1816, the net public debt of the UK reached 240 per cent of gross domestic product. This was the fiscal legacy of 125 years of war against France. What economic disaster followed this crushing burden of debt? The industrial revolution.
Yet Carmen Reinhart and Kenneth Rogoff of Harvard university argued ... that growth slows sharply when the ratio of public debt to GDP exceeds 90 per cent. The UK’s experience in the 19th century is such a powerful exception...
I agree with the critics for reasons given by Gavyn Davies. The argument that data covering a long period of high debt should count for more than data covering a short one is persuasive. ...
[A]fter a financial crisis, a huge excess of desired private savings is likely to emerge... In that situation, immediate fiscal austerity will be counterproductive. ... This is why I was – and remain – concerned about the intellectual influence in favor of austerity exercised by profs Reinhart and Rogoff, whom I greatly respect. The issue here is not even the direction of causality, but rather the costs of trying to avoid high public debt in the aftermath of a financial crisis. In its latest World Economic Outlook, the IMF notes that direct fiscal support for recovery has been exceptionally weak. Not surprisingly, the recovery itself has also been feeble. One of the reasons for this weak support for crisis-hit economies has been concern about the high level of public debt. Profs Reinhart and Rogoff’s paper justified that concern ... This was a huge blunder. It is still not too late to reconsider.

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