Debt and economic growth: Is there any causal effect? An empirical analysis with structural breaks and Granger causality for Greece

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1 Theoreical and Applied Economics Volume XXI (204), No. (590), pp Deb and economic growh: Is here any causal effec? An empirical analysis wih srucural breas and Granger causaliy for Greece Sylianou TASOS Universiy of Macedonia Absrac. During he las decade Greece has faced many economic problems. The economy is eeering on he brin of banrupcy and he deb deepens. In his paper we will examine wheher he deb is promoing economic growh in Greece. We use ime series daa from 980 o 200. The daa is fied ino he regression equaion using economeric echniques such as Phillips Perron, Augmen Dicey Fuller and KPSS. We are esing he variables wih echniques such as Zivo Andrew s, Perron s and Bai Perron s ess o find any srucural breas. Then we are esing o see if here is any causal effec in our model wih Granger causaliy es. The resuls reveal ha here are srucural breas in he economy of Greece bu no causaliy beween he variables. Keywords: economic growh, public deb, srucural breas, Bai Perron es, Granger causaliy. JEL Classificaion: A0, C32, N5. REL Classificaion: 8E.

2 52 Sylianou Tasos. Inroducion During he recen decade, many developing counries are facing economic problems and high levels of indebedness. Greece is one of he counries of he European Union (E.U) which facing maor economic problems. There is no doub ha i is a a very criical uncure of is recen hisory and he danger of banrupcy is very close. 2. Lieraure review There is a wide body of lieraure, analyzing he relaionship beween deb and economic growh in boh developed and developing counries. Eaon (993) found ha for developing counries i is expeced ha he marginal produc should be higher han he world ineres rae. Because of ha such counries would benefi from exernal borrowing. Afxeniou (993) argues ha high levels of deb have a negaive effec on economic growh. According o Krugman (988) deb overhang defined as he siuaion in which he expeced repaymen on exernal deb falls shor of he conracual value of deb, and herefore expeced deb service is liely o be an increasing funcion of he counry's oupu level. In many empirical research he negaive effec beween exernal deb and economic growh is aribued o deb overhang Many researchers (e.g. Savvides (992), IMF (989) and Greene and Villanueva (99)) claim ha he negaive relaionship and he low growh raes are due o he fac ha he high levels of exernal deb lead he privae invesmen o a reducion. In he lieraure here is grea ineres abou he effecs of deb on economic growh for developing counries. Using OLS esimaion mehod for a sample of 8 developing counries, Cohen (993) esimaed an invesmen equaion. He shows ha he slowdown of invesmen in developing counries canno be explained by he level of deb. Cunningham (993), using a sample of sixeen heavily indebed naions, examined he relaionship beween economic growh and he level of (oal) deb. The auhor found ha ha deb has a negaive effec on he economic growh as he produciviy of capial and labour are significanly reduced. Also Deshpande (997) find negaive relaionship beween exernal deb and economic growh for developing counries. The auhors Rocerbie (994) and Sawada (994) in heir wors indicae ha he decrease in economic growh and invesmen is due o he exernal deb. Were (200), ried o analyze he deb overhang problem (Kenya) and find evidence for is impac on economic growh. He used daa from 970 o 995, bu he didn find any impac. In a recen wor Paillo, Poirson and Ricci (2002) find ha he average impac of deb on per capia GDP growh is negaive only for

3 Deb and economic growh: Is here any causal effec? 53 high levels of deb. Similarly Schclare (2004) employing ime series daa over a period of 970 o 2002 for 83 developing and indusrial counries didn find evidence abou he relaionship beween deb and produciviy. In his sudy he finds ha for developing counries a higher growh rae is associaed wih a lower deb level. Mohamed (2005), invesigaed he relaionship deb indebedness and economic growh for Sudan using annual daa from 978 o He found ha inflaion and deb aver growh. On he oher hand he found expors o have a posiive effec on economic growh. Adepou e al. (2007) analyzed he economy of Nigeria using daa from 962 o They concluded ha economic growh for Nigeria is hampered by he deb. Focusing on 6 Pacific Island counries for he period Jayaraman e al. (2008), concluded ha here is a significan posiive relaionship beween deb and GDP, and inverse relaionship beween growh and higher fiscal defici. In a recen survey Hameed a al. (2008) ried o explore he effec of deb, capial soc and labour force on growh for a period of for Paisan. They found ha economic growh is hampered by he adverse effec of deb on capial produciviy and labour. Focusing on 27 Lain American and Caribbean counries for he period , Bus (2009) ried o invesigae he relaionship beween economic growh and deb. He found ha here is evidence of Granger causaliy in half of hese counries (3). 3. Daa This sudy uses annual ime series daa on GDP per capial and Gross Deb (as percenage on GDP) sourced from IMF (Inernaional Moneary Fund). The daa cover he period beween 980 and 200 in Greece. The logarihm of GDP and Exernal Deb are used in he empirical analysis. The ransformaion of he series o logarihms is inended o eliminae he problem of heerosedasiciy. 4. Economeric mehodology According o Ogunmuyiwa (20) we use he model GDP = f DEBT ) and GDP = β β ( 0 DEBT ) µ ( In order o avoid spurious regression oucomes on he ime series daa, we are using uni roo ess ha affirm he saionariy of he series. In his paper we use wo inds of uni roos ess. Firs of all we use he radiional uni roos ess which do no ae ino accoun srucural breas such as Augmened Dicey- Fuller (ADF) ess (Dicey and Fuller, 979 and 98) he Phillips-Perron es (988) and he es of Kwiaowsi e al. (992). The second ind of uni roo

4 54 Sylianou Tasos ess we use are he ess ha ae ino accoun one srucural brea such as Zivo and Andrews (992) and Perron (997). The hird mehod we use in he paper is he Bai Perron(998, 200) mehod for esimaing linear regression models subec o muliple breas. Finally we have used Granger causaliy analysis in order o invesigae he relaionship beween GDP and Exernal Deb. 4.. Uni roo ess wihou srucural brea 4... ADF es y y d y ε = c α y () β d y ε = c α y (2) The firs equaion () ess he null of a uni roo agains a mean saionariy in y (y is he ime series we examine each ime). The second equaion (2) ess he null of a uni roo agains he alernaive of rend saionariy ( Y- is lagged firs differences) Phillips Perron (PP es) The PP es (988) maes he semi parameric correcion for auocorrelaion and i s more powerful in he case where we have wealy auocorrelaion and heerosedasic regression residuals. We can say ha Phillips Perron es is an exension of he ADF es KPSS es Unlie mos of he uni roo ess Kwiaowsi-Phillips-Schmid-Shin (992) provide a es where he null hypohesis is ha a series is saionary. The es has been developed o complemen uni roo ess as he las have low power wih respec o near uni roo and long run rend process Uni roo ess wih srucural brea Zivo and Andrews model Zivo and Andrews (992) proceed wih hree models o es for a uni roo: model A, which permis a one-ime change in he level of he series; model B, which allows for a one-ime change in he slope of he rend funcion, and model C, which combines one-ime changes in he level and he slope of he rend funcion of he series. The 3 models are Y β * θdu d Y = κ α * Y ε (Model Α)

5 Deb and economic growh: Is here any causal effec? 55 Y β * γ DT d Y = κ α * Y ε (Model Β) Y β * ϑdu γ DT d Y = κ α * Y ε (Model C) DU is an indicaor dummy variable for a mean shif occurring a each possible brea-dae (TB) while DT is corresponding rend shif variable: if f TB TB if f TB DU = and DT = 0 oherwise 0 oherwise The null hypohesis in all he models is ha α=0, which means ha he series {y} conains a uni roo wih a drif ha excludes any srucural brea. The alernaive hypohesis is ha α<0. I implies ha he series is a rend-saionary process wih a one-ime brea occurring a an unnown poin in ime Perron es Perron (997) proposed a uni roo es which allows for an endogenous srucural change. According o Perron (997, p.358) we have 2 equaions. In he firs model he uni roo es is performed using he saisic for esing a= in he following regression: Y ci Y i= = µ ϑdu β δd( T ) αy e (3) b where: DU = ( f Tb ) and D ( T b ) = ( = T b ), T b denoes he ime a which he change in he rend funcion occurs; is a linear ime rend; is he firs-difference operaor; e are whie noise error erms. Moreover, as he second model (Model 2), he es is performed using he -saisic for he null hypohesis ha α= in he regression: Y * ci Y i= = µ ϑdu β γdt δd( T ) αy e (4) b where: DT = ( f T b ) is he dummy variable. We conduc regression (2) for 3 Tb T 3. In he above equaions () and (2), he brea dae, Tb, and lag lengh,, are reaed as unnown. The brea dae, Tb, is seleced based on he minimum -saisic for esing α = (see Perron, 997, pp ). For each Tb, he selecion of lag lengh,, is seleced by -sig crierion wih maximum lag lengh, max = 5 (see Perron, 997, p. 359). *

6 56 Sylianou Tasos The Bai-Perron mehod Bai and Perron (998, 200) proposed a mehod for esimaing linear regression models subec o muliple breas. The model assumes ha he dependen variable, y, is relaed o a se of sae variables, x bu ha he relaionship has been subec o q breas up o ime T : y x uˆ =,2,..., T y... y = β = β x uˆ 2 = T,..., T2 β uˆ = Tq,..., T = q x T p T2 p... p Tq p T and U is a is a disurbance erm. The Bai and Perron mehod permis consisen esimaion of he number and locaion of he breapoins and he parameers. The model i s possible o be resriced o allow parial breas ha only affec some of he regression coefficiens. Because he breas are viewed as deerminisic and he approach hus does no require specifying he underlying process ha generaed he breas in he firs place. The approach relies on a number of design parameers such as he maximum number of breas and he minimum disance beween breas. We can deermine he number of he breas wih many ways. One approach is o deermine he number of breas sequenially by esing for q agains q breas. Alernaively a global approach of esing for q breas agains no breas can be used. Finally, he number of breas can be seleced by using penalized lielihood mehods such as he Schwarz informaion crierion (SIC) or Aaie s informaion crierion (AIC) which differ in erms of he penaly hey apply o he inclusion of addiional breapoin parameers. All of he above and oher pracical issues are furher discussed in Bai and Perron (200) Granger causaliy es The es procedure as described by (Granger, 969) is illusraed below: GDP = K A ED i K B GDP Ui (5) DEBT = K C DEBT i i K D GDP U 2. (6)

7 Deb and economic growh: Is here any causal effec? 57 Equaion (5) represens ha curren GDP is relaed o pas values of iself as well as ha of DEBT and vice- versa for Eq. (6).Unidirecional causaliy from DEBT o GDP is indicaed if he esimaed coefficien on he lagged DEBT in equaion (5) are saisically differen from zero as a group and he se of esimaed coefficiens on he lagged GDP in Eq. (6) is no saisically differen from 0.The converse is he case for unidirecional causaliy from GDP o DEBT. Bilaeral causaliy exiss when he ses of DEBT and GDP coefficien are saisically differen from 0 in boh regressions (Guarai, 2004). (Noe: we are using he variables in firs differences) 5. Empirical Resuls 5.. Uni Roo Tess wihou Srucural Brea Before we will proceed o he analysis we have o deermine he inegraion order of he variables. The resuls of he ess we have used are presened in able. All he variables are expressed in naural logarihms so ha elasiciies can also be deermined. Table. Uni Roo Tess wihou Srucural Brea Dicey Fuller Phillips - Perron KPSS τ µ τ τ τ µ [0.059] [0.952] [0.337] [0.027] * *** τ τ η µ η τ ** 0.698*** [0.333] ** 0.82** [0.369] LGDP 0.63 [0.965] LDEBT [0.022] LGDP ** [0.03] [0.073] [0.005] [0.02] LDEBT *** ** *** *** [0.004] [0.009] [0.003] [0.008] Noes: τµ is he -saisic when a ime rend is no included in he equaion and τ τ is he -saisic when a ime rend is included in he equaion. The calculaed saisics are hose repored in Dicey-Fuller (98). The criical values for he ess of Dicy Fuller and Phillips Perron are a % 3.67, a 5% 2.96 and a 0% 2.62 for τµ and 4.36, 3.60 and 3.23 for ττ respecively. η µ and ητ are he KPSS saisics for esing he null hypohesis ha he series are I(0) when he residuals are compued from a regression equaion wih only an inercep and inercep and ime rend, respecively. The criical values a %, 5% and 0% are 0.739, and for ηµ and 0.26, 0.46 and 0.9 for ητ respecively (Kwiaowsi e al, 992, Table ). ***, **, * indicae significance a he, 5 and 0 percenage levels. The resuls according o he ess of ADF, Phillips-Perron and KPSS saisics, have showed ha all he explanaory variables are inegraed of order I ().

8 58 Sylianou Tasos 5.2. Zivo Andrews resuls Table 2. Zivo Andrew s es -Saisic Prob. * Brea Poin Zivo-Andrews es saisic (DLGDP) Zivo-Andrews es saisic (DLDEBT) % criical value: % criical value: % criical value: The resuls for Zivo and Andrew uni roo es are presened in Table 2. The resuls sugges ha we can reec he null of uni roo for GDP and DEBT. A he same ime, he es idenifies endogenously he poin of he mos significan srucural brea in every ime series examined in he paper. Table 2 ells us abou he brea daes for each variable. The Brea poin for he variable of DEBT is 994 (since 994 he raio of deb o GDP has remained above 94% and afer ha year he raio rapidly grew above 00%). The Brea poin for he variable of GDP was 2003 (afer ha year he real GDP growh raio sared o fall Figure. Zivo Andrew s Breapoin for DLGDP (2003) Figure 2. Zivo Andrew s Breapoin for DLDEBT (994)

9 Deb and economic growh: Is here any causal effec? Resuls of Perron s uni roo es Table 3. Perron s Uni Roo Tes -Saisic Brea Poin Perron Uni Roo Tes (DLGDP) Perron Uni Roo Tes (DLDEBT) % criical value: % criical value: % criical value: As we can see from he resuls which are presened in able 3 he brea poins for he variables of GDP and DEBT are 2002 and 993 respecively. If we will compare he resuls of he wo ess we see ha hey are slighly differen (hey differ by one year). The resuls of he Perron s es have shown a brea poin one year earlier ha he Zivo Andrews es Figure 3. Perron s Breapoin DLGDP (2002) Figure 3. Perron s Breapoin DLDEBT (993)

10 60 Sylianou Tasos 5.4. Resuls of Bai-Perron s breapoin es The nex es we have obained was he Bai-Perron s breapoin es. In able 4 we repor he opimal number of breapoins (i.e he one associaed wih he minimum BIC score or he maximum Log Li score). The opimum number of breapoins we have in our model is 3 and he breas were in year 986, 992 and 200. Table 4. Bai-Perron s breapoin Tes Breapoins BIC Log-Li RSS N. Coefs Chosen number of breas: 3 Breas : Granger causaliy es Table 5. Granger causaliy es Null Hypohesis: Obs F-Saisic Prob. DLDEBT does no Granger Cause DLGDP DLGDP does no Granger Cause DLDEBT Having affirmed he saionariy of he series, we hen proceed o find he causaliy using he Granger causaliy es as defined by Granger (969). The resuls are shown in Table 5 and clearly we can conclude ha hey fail o suppor any sric causaliy beween Deb (DEBT) and economic growh in Greece. Thus, i can be affirmed ha he variables are exogenous of one anoher, bu he degree of exogeneiy beween he variables canno be deermined easily. Hence, i can be saed ha exernal deb is no a specific facor deermining he rae of economic growh or economic slowdown in Greece. Our finding is in confinemen wih he findings of Afxeniou and Serleis (996a) who saed ha indebedness is no a specific facor of per capial income growh. Also our findings are in confinemen wih Bullow and Rogof (990) proposiions ha public deb of developing counries is a sympom raher han a cause of economic slowdown. 6. Conclusions In his paper we are rying o deermine if economic growh can be promoed by deb in Greece. Many researches have shown ha causaion beween deb and growh could no be esablished in developing counries and public deb could hus no be used o forecas improvemen or slowdown in economic growh in Greece.

11 Deb and economic growh: Is here any causal effec? 6 In order o examine ha relaionship we have used some saionariy ess. Firs of all we have used he radiional uni roos ess which do no ae ino accoun srucural breas such as Augmened Dicey-Fuller (ADF) ess (Dicey and Fuller, 979 and 98) he Phillips-Perron es (988) and he es of Kwiaowsi e al. (992). The resuls have shown ha all of our variables are saionary of order one. The second ind of saionariy ess we have used are he ess ha ae ino accoun one srucural brea such as Zivo and Andrews (992) and Perron (997). Here we have found ha wih Zivo and Andrews s mehod he Brea poin for he variable of DEBT was 994 and for he variable of GDP was The resuls of Perron s es were slighly differen and give us differen brea poins for he variables (GDP and DEBT are 2002 and 993 respecively). We have used also he Bai Perron s (998, 200) mehod for esimaing linear regression models subec o muliple breas. The es has shown ha he opimum number of breapoins we have is 3 and he breas were in year 986, 992 and 200. Finally we have used Granger causaliy analysis in order o invesigae he relaionship beween GDP and Public Deb. The resuls suggesed ha we canno esablish causaliy beween deb and growh in Greece. References Adepou, A.A., Salau, A.S. and Obayelu, A.E. (2007). The Effecs of Exernal Deb Managemen on Susainable Economic Growh and Developmen: Lessons from Nigeria, MPRA Paper, no. 247 Afxeniou, P.C. (993). GNP growh and foreign indebedness in middle-income developing counries, Inernaional Economic Journal 7(3), pp Bai, J., Perron, P. (998). Esimaing and esing linear models wih muliple srucural changes. Economerica, 66, pp Bai, J., Perron, P. (200). Muliple srucural change models: A simulaion analysis. Boson Universiy, Manuscrip Bus, H.C. (2009). Shor Term Exernal Deb and Economic Growh Granger Causaliy: Evidence from Lain America and he Caribbean, The Review of Blac poliical economy 36, pp. 93- Eaon, J. (993). Sovereign Deb: A Primer, World Ban Econ. Rev., 7(3), pp Cohen, D. (993). Low invesmen and large LDC deb in he 980s, American Economy Review, 83(3), pp Cunningham, R.T. (993). The effecs of deb burden on economic growh in heavily indebed developing naions, Journal of Economic Developmen 8(), 5{26 Dicey, D.A., Fuller, W.A. (979). Disribuions of he esimaors for auoregressive ime-series wih a uni roo, Journal of he American Saisical Associaion, 74 (3), pp Dicey, D.A., Fuller, W.A. (98). Disribuion of he esimaors for auoregressive ime series wih a uni roo, Economerica, 49, pp Deshpande, A. (997). The deb overhang and he disincenive o inves, Journal of Developmen Economics 52(), pp

12 62 Sylianou Tasos Granger, C.W.J. (969). Invesigaing causal relaion by economeric and cross-secional mehod, Economerica 37, pp Guarai, D.N. (2004). Basic Economerics, 4h ediion, McGraw-Hill Boo Co. Greene, J., Villanueva, D. (99). Privae invesmen in developing counries. IMF Saff Papers 39(), pp IMF (989). World Economic Ouloo, Supplemanary Noe (IMF) Hameed, A.H., Ashraf, M.A.C. (2008). Exernal Deb and is Impac on Economic and Business Growh in Paisan, Inernaional Research Journal of Finance and Economics, 20, pp Jayaraman, T.K. Evan L. (2008). Does exernal deb lead o economic growh in Pacific Island counries, Journal of Policy Modeling, 3, pp Krugman, P. (988) Financing vs. forgiving a deb overhang, Journal of Developmen Economics 29(3), pp Kwiaowsi, D., Phillips, P.C., Schmid, P., Shin, Y. (992) Tesing he null hypohesis of saionariy agains he alernaive of a uni roo, Journal of Economerics, 54, pp Mohamed, Muasim Ahmed Abdelmawla (2005). The Impac of Exernal Debs on Economic Growh: An Empirical Assessmen of he Sudan: , Easern Africa Social Science Research Review, 2(2): pp Ogunmuyiwa M.S. (20). Does Exernal Deb Promoe Economic Growh in Nigeria?, Curren Research Journal of Economic Theory, vol. 3 Issue:, pp Paillo, Caherine A., Poirson, Helene, Ricci, L.A. (2002). Exernal deb and growh, IMF Woring Papers 02/69, Inernaional Moneary Fund Perron, P. (997). Furher Evidence on Breaing Trend Funcions in Macroeconomic Variables, Journal of Economerics, 80 (2), pp Phillips, P.C.B, Perron, P. (988). Tesing for a Uni Roo in Time Series Regressions, Biomeria 75, pp Rocerbie, D.W. (994). Did he deb crisis cause he invesmen crisis? Furher evidence, Applied Economics 26(7), pp Savvides, A. (992). Invesmen slowdown in developing counries during he 980s: Deb overhang or foreign capial inflows, Kylos 45(3), pp Sawada, Y. (994). Are he heavily indebed counries solven?: Tess of ineremporal borrowing consrains, Journal of Developmen Economics 45(2), pp Schclare, A. (2004). Deb and Economic Growh in Developing and Indusrial Counries, Lund Universiy, Deparmen of Economics in is series Woring Papers wih number 2005, p. 34 Were, Maureen (200). The Impac of Exernal Deb on Economic Growh in Kenya: An Empirical Assessmen, UNU-WIDER Research Paper, DP200/6 Zivo, E., Andrews, D. (992). Furher evidence of grea crash, he oil price shoc and uni roo hypohesis, Journal of Business and Economic Saisics, 0, pp