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Empirical Economics
Erschienen in:

17.07.2017

Public debt dynamics: the effects of austerity, inflation, and growth shocks

verfasst von: Reda Cherif, Fuad Hasanov

Erschienen in: Empirical Economics | Ausgabe 3/2018

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Abstract

We study the impact of macroeconomic shocks on US public debt dynamics using a VAR with debt feedback. Following a primary balance, or austerity, shock, the debt ratio initially declines but at a cost of lower growth. The debt ratio then rises to its pre-shock path, suggesting the austerity shock could be self-defeating. An inflation shock reduces the debt ratio initially, while a positive growth shock unambiguously lowers debt. Our specification, properly incorporating the debt equation, produces different debt impulse responses and forecasts from VAR models either excluding debt or including debt linearly.
Vorheriger Artikel Internalization of externalities and local government consolidation: empirical evidence from Japan
Nächster Artikel Accelerating the transition to employment at benefit exhaustion: still possible after four years of unemployment?

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Fußnoten
1
See Delong and Summers (2012) and more recently, Fatas and Summers (2015) on the permanent effects of fiscal consolidation. Furthermore, the IMF (2010) has shown that a 1% point reduction in the fiscal balance leads to about one-half percent reduction in the growth rate. Cottarelli (2012) argues that lower growth may in fact increase the interest rates, further offsetting the impact of consolidation. In addition, Blanchard (2011) points to the “schizophrenic” behavior of markets with respect to growth and consolidation.
 
2
Hall and Sargent (2011) show that about 80% of the 85% of GDP debt reduction in 1946–1974 in the US is attributed to growth and primary surpluses (about equally split). The rest is due to inflation.
 
3
With the short rate at the zero bound and a weak economy, high interest rates are not likely to be problematic in the short run.
 
4
Fiscal reaction functions estimated in the literature include the debt ratio. The debt ratio can also affect growth (Kumar and Woo 2010) and interest rates (Baldacci and Kumar 2010) and thus should be included in all VAR equations.
 
5
While they focus on fiscal multipliers, we study instead the effects of shocks on public debt.
 
6
Hasko (2007) and Corsetti et al. (2009) incorporate public debt as another linear VAR equation. Others employ long-term cointegration approach (Boissinot et al. 2004; Polito and Wickens 2007) or do not include debt in the VAR (Tanner and Samake 2008). Chung and Leeper (2007) use a VAR with cross-equation restrictions arising from the present-value condition of debt sustainability. Barro (1980) studied the effect of US public debt shocks on output and unemployment using regressions without the VAR dynamics.
 
7
See Celasun and Keim (2010) for an application to the USA.
 
8
See also Agnello et al. (2013a), Agnello and Sousa (2013b), and Agnello and Sousa (2014).
 
9
The model does not include the marginal interest rate such as the Treasury bill rate or the fed funds rate controlled by the Federal Reserve. The difference between the average interest rate on debt and the Treasury bill rate would narrow with a short debt maturity, which has been decreasing over time. Moreover, the correlation between the average interest rate on debt and the Treasury bill rate is above 80%, suggesting that our model captures the interest rate dynamics relatively well. In interpreting impulse responses, a shock to the average interest rate would imply a larger underlying shock to the marginal rate.
 
10
We ignore the debt residual, including non-deficit financing, in our specification. For the USA, the debt residual was historically marginal as shown in Favero and Giavazzi (2007) for the period between 1947 and the end of the century.
 
11
We tested the stationarity of the series using unit root tests (both using the whole sample 1947–2015 and the 1980–2007 sample). Overall, tests suggest that growth, inflation, and primary deficit series are stationary. Although standard tests in general suggest that interest rate and debt ratio are non-stationary, their high persistence imply that the unit root tests have low power. Moreover, accounting for structural breaks, interest rate is usually found to be stationary (Neely and Rapach 2008). Bohn (1998, 2005) finds that there is no conclusive evidence of the non-stationary debt ratio and that primary surplus responds positively to the growing debt ratio with the debt ratio mean-reverting.
 
12
The procedure is as follows: (i) resample residuals from the original VAR and compute new Y and corresponding d; (ii) reestimate the VAR, identify shocks, and compute IRs; (iii) repeat steps (i) and (ii) 1000 times to obtain bootstrapped distributions of IRs and compute confidence intervals.
 
13
We also used Monte Carlo normal sampling and obtained similar results, which indicated that shocks were likely to be Gaussian.
 
14
Koop et al. (1996) describe in detail how to compute IRs.
 
15
The data used in the current version of the paper were updated going back to 1947 (the data update as of October 2015). The results based on the older vintage of the data (December 2011) were starker in showing that an austerity shock resulted in much larger confidence bands in a weak economy, thus increasing the risk of an increasing debt ratio despite fiscal consolidation.
 
16
See the discussion “The optimal speed of debt correction” on Simon Wren-Lewis blog (mainly macro) on March 20, 2012 (available: http://​mainlymacro.​blogspot.​co.​uk/​2012/​03/​optimal-speed-of-debt-correction.​html).
 
17
The GIR identification is used.
 
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Metadaten
Titel
Public debt dynamics: the effects of austerity, inflation, and growth shocks
verfasst von
Reda Cherif
Fuad Hasanov
Publikationsdatum
17.07.2017
Verlag
Springer Berlin Heidelberg
Erschienen in
Empirical Economics / Ausgabe 3/2018
Print ISSN: 0377-7332
Elektronische ISSN: 1435-8921
DOI
https://doi.org/10.1007/s00181-017-1260-3

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