Causality between Public Debt and Real Growth in the OECD: A Country-by-country Analysis

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Economic Papers: A journal of applied economics and policy, ISSN: 0812-0439, Vol: 36, Issue: 2, Page: 156-170

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Luiggi Donayre; Ariuna Taivan
Economics, Econometrics and Finance
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We analyse the direction of causality between public debt and real economic growth in a sample of 20 OECD countries for a period of 40 years starting in 1970. Given the persistence of real growth rates, we estimate canonical cointegrating regressions to allow for the possibility of stochastic cointegrating vectors. We then make inferences about the direction of causality by means of both Granger tests and VAR-based tests that do not depend on whether the series are integrated or cointegrated. We found that while modern welfare states tend to face low real growth following increases in public debt, more traditional welfare states and those with larger governments typically exhibit either causality from low growth to debt accumulation or bidirectional causality. However, the heterogeneity of the results suggests caution when making general statements about the relationship between these variables. In particular, the causal link is intrinsic to each country and it cannot be inferred that higher debt always leads to lower economic growth.