04/19/2013 02:01 pm ET

Fitch Downgrades UK, Citing 90% Debt Threshold Used In Discredited Austerity Research


Here's an example of why credit-rating agencies might have a bit of a credibility problem.

On one of the most dramatic news days in recent history, Fitch Ratings took the opportunity on Friday to cut its credit rating for the United Kingdom's sovereign debt to AA+ from AAA. This had zero real-world impact and little news value, but there was one interesting thing about it: The agency based the downgrade on the U.K.'s inability to get its debt down to 90 percent of gross domestic product.

If that number sounds familiar, that's the threshold made famous by an economic research paper often used to justify government austerity, research that just this week was revealed to be full of errors.

The research paper in question, written in 2010 by Carmen Reinhart and Kenneth Rogoff of Harvard University, suggests strongly that horrible things happen to economies when public debt rises to 90 percent of GDP. In the years since its publication, it has been cited by everyone from eurozone policymakers to Rep. Paul Ryan (R-Wis.) in advocating for austerity measures around the world.

A University of Massachusetts grad student and his professors this week revealed the paper to be full of errors, including an embarrassing mistake made when creating a simple Excel spreadsheet formula. Reinhart and Rogoff responded that, although some of their findings did turn out to be mistakes, their overall conclusion was still valid: Economic growth tends to slow in economies with debt-to-GDP ratios above 90 percent.

However, it doesn't slow by very much, and Reinhart and Rogoff have never been able to answer the critical chicken-egg problem at the heart of their research: Does high debt cause low growth, or the other way around?

Fitch did not cite the Reinhart-Rogoff research by name when announcing the downgrade, and debt thresholds are standard fare for ratings agencies. But, Fitch has not explained why it considers 90 to be the magic percentage for the U.K.'s credit rating.

Fitch did not immediately return a request for comment.

The ratings agency first warned about the 90-percent debt threshold last September, writing:

"A downgrade of the U.K.'s 'AAA' sovereign rating would likely be triggered by ... General government gross debt failing to stabilise below 100% of GDP and on a firm downward path towards 90% of GDP over the medium-term." It repeated that language in its downgrade on Friday.

Back in March 2012, when Fitch first cut the U.K.'s outlook to "negative," it said "historical and international precedent" suggested that the U.K.'s debt levels were going to get too high to justify a AAA rating. That has echoes of the Reinhart-Rogoff research, which studied the historical and international precedents of debt and economic growth.

Ironically, the main reason the U.K.'s debt level is rising relative to its GDP is because its economy is ice cold, thanks in part to the austerity measures of its government -- "fiscal consolidation," as Fitch put it in September.

Fortunately, the Fitch downgrade will not raise the U.K.'s borrowing costs or anything like that. Moody's had already downgraded the U.K., and the credit market usually adjusts several years ahead of the rating agencies anyway.

But it is a reminder of the economic impact of austerity -- austerity helped along by a research report that will likely keep influencing policymakers, and maybe rating agencies, for years to come -- despite its massive flaws.