In this post we analyze the long-term relationship between public debt and growth in Spain based on the results of our last article within a research project funded by FUNCAS. It is evident that this relationship has gained a renewed interest, being at the epicenter of the current debate on fiscal stimuli in the face of fiscal consolidation. We will all remember the intense reaction (and not only for the mistakes made) that the famous article by Reinhart and Rogoff raised about the existence of a threshold beyond which the volume of debt had a negative effect on growth ( here).
Needless to say, the debt-growth relationship is complex, due to the existence of interconnections and bidirectional effects between both variables in the short and long term. Therefore, what we are trying to do here is to unravel this link and quantify its importance by using Spain as a case study. This is a topic of great economic relevance that has been treated at other times, and from different angles, in this blog (for example here or here ).
There are several channels through which public debt can influence long-term economic growth. First, the tax increases necessary to pay for a high level of public debt can displace private investment, reducing the income and savings available, raising the distorting costs of the tax burden and giving rise to a probable tax treatment. not neutral between types of assets, which increases the distortions themselves. Secondly, high levels of indebtedness boost the long-term rates of sovereign debt non-linearly, since the risk of default also increases.
High long-term interest rates reduce productive public investment and, more importantly, displace private investment by raising the cost of capital. A reduction in investment in R & D will lead to long-term negative effects on growth. Third, economic authorities, especially in countries with weak institutional systems and low collection capacity, can decide on an inflationary financing of the debt by partially monetizing it, which has negative effects on saving, investment and growth (for more details seehere , here or here ).
The recent empirical literature has tried to clarify and explain the possible relationship between public debt and economic growth from a historical perspective. However, the evidence is still relatively scarce, inconclusive and not without controversy (see, here , here or here, among others). Although the theory predicts a long-term relationship between the two variables analyzed, the use of cointegration techniques of time series has been relatively scarce and, in general, has not been controlled by the existence of discontinuities in the estimated relationships, which may have led to problems in the estimated parameters when making inference or prediction.
This problem is especially serious in the case of long-term studies that cover different historical stages in which the variables may have been subject to external shocks or changes in economic policy. In the case of Spain, a remarkable effort has been made by economic historians to provide high quality historical series that allow applying econometric methods, facilitating the development of the so-called Cliometry .
The analysis of sovereign debt in Spain from a historical point of view and its economic consequences has been studied by several authors, highlighting the seminal works of Francisco Comín collected in a recent book . As we will see, our analysis coincides in large part with its conclusions.
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