In the aftermath of Rogoff and Reinhardt’s study on debt sustainability and growth, economists seldom enquire on the inevitability of public debt for growth. Marianna Mazzucato and Stephanie Kelton each advocate, in a particular way, that public spending and thus public debt contributes to economic growth and development. Other economists, including Nobel laureates Mundell and Krugman, also acknowledge the role of public debt in underpinning or stimulating economic activity.
Less frequently, economists explore public spending as necessary to achieve society’s growth objectives. Private investment strains resources often funded by the public sector from infrastructure to knowledge that increase the pressure to ramp-up public spending.
Using US data, I regress earnings, spending and saving of each public, corporate and consumer sectors of the economy on GDP-weighed debt to produce a close-to-fit model of variables explaining debt. Notice these regressions are applicable only to the US economy – different economies exhibit different relationships between public revenue and spending, with significant implications to debt accumulation.
I also regress the same variables on nominal public debt to improve fitness.
In the Government sector, I regress Federal Government tax receipts, net government savings, real consumption of fixed capital and total spending to find that each increases nominal debt – except for total spending. By inverting the log coefficients, I find the following relation between sectoral income, spending and saving and public debt:
Research by Owoye and Onafowora explores the causal links between tax revenue and spending, observing the existence of a neutral relation between public revenue and spending in the United States, comparable to the results attained in the Toda-Yamamoto research. Owoye and Onafowora do find a statistically significant causal relation between revenue and spending in other countries that suggests government may opt to offload some of the investment burden to public debt. These results substantiate positive regression coefficients for both Tax Revenue and Real consumption of fixed capital: government may increase spending (for instance in fixed capital) when revenues increase, offloading some of the effort in debt.
Arguably, the results suggest some form of Institutional Separation operating in the US where an increase in revenue or spending does not imply a concomitant increase or contraction of the other.
The results for total expenditure are understandable in the context of how the US government uses current expenditure to smooth the business cycle in the private sector (by stimulating employment creation that would otherwise depress revenues) and spread the cost of capital investment through several budgetary cycles. The latter explanation is concomitant with the significant role consumption of fixed public capital in explaining the US debt burden.
As public spending infrastructure seems the most significant determinant of public debt, it is not surprising to find coefficients different from zero in what concerns corporate earnings, spending and saving. Firm profitability seems to increase public debt, the effect becoming stronger as I lag the variable by up to three quarters without affecting significance. Profitability is an intervening variable in public debt through Net Government Saving (that becomes less significant as I lag Profitability) as accounted for by the Levy equation: corporate profits increase with the public deficit, thus increasing profits imply lower debt. Concurrently, the Levy equation indicates net investment negatively affects government saving, typically implying increasing debt.
The macro entity hints at the micro foundations of how firm behaviour determines public debt. Levy’s framework assumes government spending increases corporate profits, thus that negative public saving (or an increase in public debt) sustains the profit level. By lagging Gross fixed capital formation by a quarter, I find thatGovernment Consumption of fixed capital would increase by 126% to compensate for lower corporate investment. These findings are complacent with both demand-side public stimulus and crowding-in of public investment by private investment through the marginal productivity channel.
Public investment crowding-in is plausible in the context of small, open economies (price takers) who increase exports such that the net international investment position improves. Both through the marginal productivity of investment as through subdued pressure on interest rates, private investment enticed by e.g. increasing exports invites the public sector to increase capital expenditure that is mostly financed by debt issuance in the United States.
Research has long established a firm link between employment (or nonfarm payrolls) and budget deficits – hence debt levels – either causal or co-integrated but certainly of opposite sign as illustrated in the following chart reproduced in Fedell and Forte who find unemployment is a long run cause of fiscal deficit. The negative sign is thus less surprising as an increase in employment seems to reduce debt.
The large coefficient found between consumer spending and public debt contradicts Ricardian equivalence while confirming Summers’s and Carroll’s results: consumer spending crowds-in public spending as both are inherently linked to foreign inflows. Summers and Carroll solve the contradiction between both positive coefficients in consumer spending and saving by observing that disposable income and the private saving rate increase in tandem with earnings – arguably, foreign inflows also fund corporate investment (that retains the expected negative coefficient observed above). The apparent Ricardian effect is likely due to foreign capital inflows, measured by liabilities to foreigners, depicted in the following regression results with positive sign when regressed on household saving.