U go Panizza and Andrea Presbitero January 2013 Alex Battistel Anthony Medina

1. Ugo Panizza and Andrea PresbiteroJanuary 2013Alex Battistel Anthony Medina PUBLIC DEBT AND ECONOMIC GROWTH IN ADVANCED ECONOMIES: A SURVEY

2. Motivation The global recession and the European public debt crisis have stimulated an intense debate about the effectiveness of fiscal policy and the consequences of rising government debt. • Abstract • Starting paper • Endogenous thresholds • Possible covariates • Endogeneity • Linear effect • Measures of debt • Conclusion

3. Abstract Thispapersurveys the recentliterature on the linksbetween public debt and economicgrowth in advancedeconomics. Manypapershavefound a negative correlationbetweendebt and growth but no one can make a strong case for a causalrelationshipgoing from debt to economicgrowth. The presence of thresholds and more generally of a non-monotone relationshipbetweendebt and growthisNOT ROBUST to small changes in data coverage and empiricaltechniques

4. «Thereis no simplerelationshipbetweendebt and growth […] There are manyfactorsthatmatters for a country’sgrowth and debt performance. Moreover, thereis no single threshold for debtratiosthat can delineate the «bad» from the «good»». (IMF, 2012)

5. Startingpoint Reinhart and Rogoff’s (2010 a,2010 b) • Annual data on debt and growth • 20 advancedeconomies from 1946 to 2009 • Splitted in 4 groups: 1) debt/GDP < 30% 2)30% < debt/GDP < 60% 3)60% < debt/GDP < 90% 4) debt/GDP > 90% Theycalculatemedian and average GDP growth for eachgroup: • No large differencesamong the first 3 groups • Substantiallylower in the fourthgroup! mediangrowth 1% lower averagegrowth 4% lower

7. Differences in mediangrowth are muchsmallerthandifferences in averagegrowth, researchersshould be careful in examining the role of outliers and test robustness with differentsources of data In fact: Souce: Minea and Parent (2012) «Is high public debtalwaysharmful to economicgrowth?» Small difference and notstatisticallysignificant

8. There are endogenousthresholds? Minea and Parent (2012) They use a Panel SmoothThresholdRegressions model • Debtnegativelyassociated with growthwhen90% <debt/GDP < 115% • Positivelyassociatedwhendebt/GDP > 115% Fiscal profligacy? Of course NOT: There are complex non-linearities, whichmaynot be captured by modelsthat use a set of exogenousthresholds.

9. Possiblecovariates of debt and growth? (1/2) Ifthere are variablescorrelated with bothdebt and growth, the simplecorrelationsdiscussedabovemaysuffer from an omittedvariablebias. The literaturehastried to addressthisissue by estimating alternative versions of thisdynamicgrowth model: • GROWTH = per capita GDP growth of country i over period t-n and t • GDP= initiallevel of per capita GDP • DEBT= debt/GDP • X=set of controls (populationgrowth, tradeopenness, inflation, …)

10. Possiblecovariates of debt and growth? (2/2) Cecchetti, Mohanty and Zampolli (2012) estimates the previous model with a 5-year overlappinggrowthepisodes • 18 OECD countries • 1980-2006 • X= nationalgrosssavings, populationgrowth, tradeopenness, inflation, agedependency ratio, a banking crysisdummyand the ratio of liquidliabilities to GDP Results: 10% debt/GDP ↗ 18 basispoints GDP growth ↘ The resultisrobust to controlling for outliers and to specificationsthat include different set of controlsvariables But: public debtvariableisnotstatisticallysignificantin regressionsthat do not include time of country fixedeffects

11. Endogeneity Evidencethatdebtisnegativelycorrelated with economicgrowth, but: • Itdoesn’timplythatdebtreducesgrowth. The link betweendebt and growthcould be thatloweconomicgrowthleads to high levels of debt or • Therecould be a thirdfactorthathas a joint effect on bothvariables

12. Panizza and Presbitero (2012) use a simplebivariate model in whichgrowth (G) is a function of debt (D) and debtis a function of growth • G = a + bD + u • D = m + kG + v OLS estimator negativelybiased. Using laggeddebtdoesn’tresolve the endogeneityproblem. Kumar and Woo (2010) experimentdifferentestimationstechniques. Addressendogeneity with with the GMM estimator system resultsconsistent with Cecchetti, Mohanti and Zampolli (2012) Problem: GMM estimatorsweredeveloped for micro data In fact: GMM coefficientslarger (in abs. Value) than the OLS.

13. Instead of internalinstruments, an alternative strategyconsists of usingexternalinstruments Checherita-Westphal and Rother (2012)instrumentdebt/GDP ratio of country i at time t with the averagedebt/GDP ratio in the other 11 countriesat time t (sample of 12 countries). non linear hump-shapedrelationshipbetweendebt and growth Maxgrowthwhen90% < debt/GDP < 100%. Problems: • Instrumentalvariablecoefficientveryclose to OLS • Validonlyif «thereis no strong relationshipbetweendebtlevels in other euro area countries and the per-capita GDP growth rate in onespecific country».

14. The public debthas a non-linear effect on growth? The simplest way to test for non-linearity consist of including a quadratic term of the debt in the growth regression. Checherita-Westphal and Rother (2012) analyse a sample of 12 euro area countries, and find a relationship between public debt and economic growth that can be described like an inverted U. They find a marginal negative effect only when the relationship is between 90 and 105 percent of GDP. This approach, however, is sensitive to extreme values ​​and a relationship like an inverted U can also be driven by a few observations.

15. An alternative way could be the introduction of more knots. Kumar and Woo (2010) analyze a sample of advanced and emerging economies using the following model: where the main variables are the same of the equation (1), and D30, D30-90 and D90 are 3 variables dummy and take value 1 when, respectively, debt is below 30, between 30 and 90, and above 90. Their results show “evidence of non-linearity, with only high (above 90 per cent of GDP) levels of debt, where we have a significant negative effect on growth”. Even if, there is a problem: the value of B2=B3 (-0,018), in the SGMM estimation, with the only difference that B2 is insignificant and B3 is marginal significant, and a simply t-test of B2=B3 can’t be rejected. This can’t confirm the hypothesis of non-linearity of debt on the growth.

16. Panel regression with Real per capita GDP GrowthasdependentvariableTable 5 taken by KUMAR AND WOO (2010): “Public Debt and Growth,”

17. Even Egert(2012) used a simple version, withoutadditional control variables,of equation (5) on a sample of advanced economies (1946-2009) allowing even four regimes with thresholds at 30, 60, and 90 percent. His results give us a negative correlation and statistically significant between debt and growth, but he doesn't find any threshold effect. His results tell us that the negative correlation between public debt and economic growth decrease if debt-GDP ratio increase. But in their paper, Cecchetti, Mohanty, e Zampolli (2012), find that the relationship between public debt and economic growth that maximizes the growth is 96%, and show that if “the debt-to-GDP ratio is above 96 percent, an increased by ten percentage points of the debt-to-GDP is correlated with a decrease of 14 basis points” (and the coefficient is statistically significant). The results are in line with the presence of a threshold around 90%, even if the model is valid only if the errors are independent and identically distributed (iid).

18. What can data say? In summary, as we have seen, the negative relation, the non-linear effect and an effect of a threshold at 90% between debt and growth are not statistically significant and not robust on all samples with different models. Also, there are evidence in other papers that a negative effect on the growth is linked only with developing country with a low democracy Kourtellos,Stengos and Tan (2012). This seems be in line with the hypothesis of the lack of a strong evidence of a causal effect, that goes from debt and arrives to the growth on the advanced economies.

19. Souce : Panizza and Presbitero (2012): “Public debt and economic growth: Is there a causal effect?Data from 16 country OECD over the period 1982-2008 to plot the aggregate and the country specific quadratic fits obtained by regression GROWTH t-(t-5) over DEBT t-5.

20. What is the right measure of public debt? Researchers should focus on gross or net debt? On the explicit or implicit debt? Measures of public debt should include the expected value of liabilities of the government? The public debt net is the difference between gross debt and financial assets of the government. However, while Net debt could seems a better measure than gross debt, his estimation are not simply with several problems of calculate.

22. Hagist, Moog, Raffelhuschen, e Vatter (2009) estimate the actual value including implicit liabilities.However, while Net debt, and the implicit debt could seem a better measure than gross debt, their estimates are not simply because there are several problems of calculate that make it difficult to compare across countries.

23. Conclusion Some economists suggest that this is the right time to apply the lessons learned during the great depression and that countries should not shy away from expansionary fiscal policy. Other economists argue that high levels of public debt have a negative effect on economic growth and that fiscal consolidation is necessary to calm the investitors. However after analyze the literature, Panizza and Presbitero, conclude that there is the lack of strong case that goes from public debt and arrive to low growth. Even, there is not evidence of a common effect threshold in advanced economies. But "stating that there is no evidence that debt has an effect on economic growth is different from stating that there is evidence that debt has no effect on economic growth “ In Panizza and Presbitero(2012),they suggest that a fully solvent government with a high level of debt may decide to do a restrictive fiscal policies to reduce the probability of a change in investors’ sentiments. So this policies can decrease the growth, and in this case high debt can reduce the growth but only because high debt led to a recessionary policies. The future research should focus on the heterogeneity (like see in the fig.3) of the single debt of the country and on the reasons and how the debt is be spent.

24. Personal opinions The debt, rather than a bad thing, it is a tool and as such depends on how it is used. The task of governments is to try to use it in the best way possible, avoiding waste and corruption In addition, for countries within the European Union, in recent years are asked to make sacrifices through austerity policies, forgetting the fact that the threshold of 3% and 60% are not taken by any mathematical formula but by compromise, mostly made 20 years ago, in a period of strong growth and in a world completely different from that of today.