Read this article also for an overview
An economic student can discover faults in professors’ models, theories and calculations
This week, economists have been astonished to find that a famous academic paper often used to make the case for austerity cuts contains major errors. Another surprise is that the mistakes, by two eminent Harvard professors, were spotted
by a student doing his homework.
The professors’ theory was that if an economy has a national debt to GDP ratio that is greater than 90% (for example, Japan), the high debt will cause economic growth to slow dramatically. I suppose they would cite the “crowding out” effect as a link. Thus they argued that the government of an economy with a high debt should cut government spending and increase taxes in order to reduce the debt.
The contrary argument is that if a country has both high debt and low or negative growth, it should try to have an expansionary policy (increase government spending and/or cut taxes) . If the expansionary policy is successful, incomes will grow and tax revenues will automatically increase while government spending on unemployment benefits will fall. Thus although debt may increase in the short run, in the long run it may decrease.
However, the professors’ research (which they used to support their theory that the first priority is to reduce the debt rather than stimulate growth) missed out some important data. Five countries with very high national debts were omitted from the spreadsheet. Yet those countries also had good growth figures.