Austerity fails – its in the numbers - The Beatings Will Continue Until Morale Improves

And the proof of that destruction is in the latest Eurostat public finance data for Europe on July 22, 2013 – Euro area government debt up to 92.2% of GDP.

The following graph shows the percentage point change in the public debt ratio (as a percent of GDP) between the first-quarter 2012 and the first-quarter 2013 for the majority of European nations. There is considerable variation. Part of the variation relates to the starting level but most of it relates to the depth of the real recession that each nation experienced and the impact that recession is having on the automatic stabilisers.

The following graph shows the percentage change in real GDP (volume index) between 2007 and 2012 (horizontal axis) and the same change in the public debt ratio (as a percent of GDP) (vertical axis) for the majority of European nations. The black line is a simple linear trend.

The causality could run either way but the evidence suggests that it runs from real GDP changes to changes in public debt ratios. The furore over the Rogoff and Reinhardt work was not really about their spreadsheet incompetence but the direction of causality. The implication of their 80 per cent threshold for “safe” public debt ratios was that once it went above that ratio, growth suffered.

There is no solid evidence to support that view. To some extent over the period analysed it is moot anyway in trying to understand why the debt ratios grew so much.

Any person will understand that the meltdown in 2008 was not a public debt event. It was a collapse in confidence that led to a spending withdrawal that cause real GDP to decline sharply.

This was followed by the imposition of fiscal austerity in most nations which further dented growth. The rise in the deficits and, under the current institutional arrangements, the rise in debt issuance, saw public debt ratios grow rapidly.

The causality is clear in this case.