Horsemeat in the Macroeconomic Sausage

Thomas Herndon, PhD student in Economics, discovered an Excel coding flaw in an oft-cited paper by economists Kenneth Rogoff and Carmen Reinhart, “Growth in a Time of Debt“, which claims that economic growth plummets when a country’s debt-to-GDP ratio exceeds 90%. The Reinhart-Rogoff paper came out just after Greece went into crisis and, in Paul Krugman’s happy words:

… played right into the desire of many officials to “pivot” from stimulus to austerity. As a result, the paper instantly became famous; it was, and is, surely the most influential economic analysis of recent years. (Paul Krugman, “The Excel Depression“)

Herndon made the discovery while taking a course in Applied Econometrics at the University of Massachusetts Amherst. One of the assignments for the course was to replicate the findings of a famous paper. Herndon’s professors, Michael Ash and Robert Pollin, almost didn’t let him take on the project because the actual prospect of taking a bunch of countries and their growth rates in various years, and averaging them together did not seem like PhD calibre work. However, when they realized what Herndon had found, the three of them agreed to co-author Herndon’s study:

We replicate Reinhart and Rogoff (results) and find that coding errors, selective exclusion of available data, and unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and GDP growth among 20 advanced economies in the post-war period. (“Does High Public Debt Consistently Stifle Economic Growth? A critique of Reinhart and Rogoff”)

What Herndon’s working paper reveals may not be rocket science, but how the macroeconomics sausage is made, and frankly, it’s not appetizing:

Most of the attention since then has focused on an Excel error that Herndon, Ash, and Pollin found — which caused five countries to be excluded from the analysis — and Reinhart and Rogoff have subsequently acknowledged. That’s pretty embarrassing, but it only changed the result by 0.3 percentage points. Most of the difference had to do instead with how Reinhart and Rogoff weighted the results from different countries. They chose to give each country’s average growth in a particular debt/GDP range the same weight, regardless of how many years the country had been in that situation. As Herndon-Ash-Pollin write, this isn’t an indefensible approach (they do argue that Reinhart and Rogoff should have devoted a lot more ink to defending it). But by taking a different approach, and instead weighting countries’ results by how many years they were above 90% debt/GDP, they were able to get a very different result. (Justin Fox, “Reinhart, Rogoff, and How the Macroeconomic Sausage Is Made“)

Seemingly small choices in how to handle the data can deliver dramatically different results.This is the recipe of mathematical chaos: small differences in initial conditions (such as those due to rounding errors in numerical computation) yielding widely diverging outcomes renders long-term prediction impossible, an effect which is popularly known as the butterfly effect. Carmen Reinhart and Kenneth Rogoff flapping their scholar wings might have provoked an authentic political hurricane.

How right Lord Keynes was when he said that the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood.

What is also worth noticing is that Carmen, Kenneth and Thomas, with the permission of Thomas’ teachers, have reached the immortality which fame confers. Whatever the outcome of the intellectual debate, they can already book a table at El Celler de Can Roca and celebrate that, thanks to them, we finally have a proper name for the current financial crisis: The Excel Depression!


Featured Image: Antonio Caparelli, A sausage man on a bench

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