Impact of Public Debt, Deficit and Debt Financing on Private Investment in a Large Country: Evidence from the United States
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Nov 23, 2020
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Abstract
This paper analyses the direct impact of fiscal variables on private investment. The current literature ignores one or more fiscal variables and, in many cases, the foreign financing of debt. In this paper, an aggregate investment function for an economy in which firms incur adjustment costs in their investment process is developed. The developed model incorporates the direct impact of government expenditure, public debt and investment, deficits and foreign-financed debt on private investment. The model is tested on US data. It is found that public investment does not have any impact on private investment, but government expenditure, deficit, debt and foreign-financed debt crowd out private investment over the long run. However, deficit crowds in the private investment over the short run.
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Kia, A. (2020) “Impact of Public Debt, Deficit and Debt Financing on Private Investment in a Large Country: Evidence from the United States”, World Journal of Applied Economics, 6(2), pp. 139-161. doi: 10.22440/wjae.6.2.3.
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References
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Ahmed, S. (1986). Railway Reforms: Do They Influence Operating Efficiency? Journal of Monetary Economics, 17, 197–224. doi:10.1016/0304-3932(86)90028-0
Alesina, A., Ardagna, S., Perotti, R., & Schiantarelli, F. (2002). Fiscal Policy, Profits, and Investment. American Economic Review, 92, 571–589. doi:10.1257/00028280260136255
Allen, R. G. (1967). Macro-Economic Theory. London, The Macmillan Press Ltd.
Ardagna, S., Caselli, F., & Lane, T. (2007). Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries. The B.E. Journal of Macroeconomics, 7, 1-33. doi:10.2202/1935-1690.1417
Aschauer, D. A. (1989). Does Public Capital Crowd Out Private Capital? Journal of Monetary Economic, 24, 171–188. doi:10.1016/0304-3932(89)90002-0
Azzimonti, M., De Francisco, E., & Quadrini, V. (2014). Financial Globalization, Inequality, and the Rising Public Debt. American Economic Review, 104, 2267–2302. doi:10.1257/aer.104.8.2267
Bai, J., & Perron, P. (2003). Computation and Analysis of Multiple Structural Change Models. Journal of Applied Econometrics, 18, 1–22. doi:10.1002/jae.659
Barro, R. J. (1981). Output Effects of Government Purchases. Journal of Political Economy, 89, 1086–1121. doi:10.1086/261024
Barth, J. R., Iden, G., Russek, F. S., & Wohar, M. (1991). The Effects of Federal Budget Deficits on Interest Rates and the Composition of Domestic Output. In R. G. Penner (Ed.), The Great Fiscal Experiment (pp. 71–141). The Urban Institute Press: Washington, DC.
Bernanke, B. S. (1983). Irreversibility, Uncertainty, and Cyclical Investment. The Quarterly Journal of Economics, 98, 85–106. doi:10.2307/1885568
Blackley, P. R. (2014). New Estimates of Direct Crowding out (or in) of Investment and of a Peace Dividend for the U.S. Economy. Journal of Post Keynesian Economics, 37, 67–90. doi:10.2753/PKE0160-3477370106
Brechling, F. (1975). Investment and Employment Decisions. Manchester, Manchester University Press.
Cheung, Y.-W., & Lai, K. S. (1993). Finite Sample Sizes of Johansen's Likelihood Ratio Tests for Cointegration. Oxford Bulletin of Economics and Statistics, 55, 313–328. doi:10.1111/j.1468-0084.1993.mp55003003.x
Chirinko, R. S., & Schaller, H. (1996). Bubbles, Fundamentals, and Investment: A Multiple Equation Testing Strategy. Journal of Monetary Economics, 38, 47–76. doi:10.1016/0304-3932(96)01267-6
Chow, G. C., & Lin, A. I. (1971). Best Linear Unbiased Interpolation, Distribution, and Extrapolation of Time Series by Related Series. The Review of Economics and Statistics, 53, 372–375. doi:10.2307/1928739
Claeys, P., Moreno, R., & Suriñach, J. (2012). Debt, Interest Rates, and Integration of Financial Markets. Economic Modelling, 29, 48–59. doi:10.1016/j.econmod.2011.05.009
Cogan, J. F., Cwik, T., Taylor, J. B., & Wieland, V. (2010). New Keynesian versus Old Keynesian Government Spending Multipliers. Journal of Economic Dynamics & Control, 34, 281–295. doi:10.1016/j.jedc.2010.01.010
Costrell, R. M. (1983). Profitability and Aggregate Investment under Demand Uncertainty. The Economic Journal, 93, 166–181. doi:10.2307/2232171
Desroches, B., & Francis, M. (2010). World Real Interest Rates: A Global Savings and Investment Perspective. Applied Economics, 42, 2801–2816. doi:10.1080/00036840801964690
Eisner, R., & Strotz, R. H. (1963). Determinants of Business Investment. In D. B. et al. (Ed.), Impacts of Monetary Policy (a series of research studies for the Commission on money and credit ed., pp. 59–338). Prentice-Hall.
Elmendorf, D., & Mankiw, N. G. (1999). Government Debt. In J. Taylor, & M. Woodford (Eds.), Handbook of Macroeconomics (pp. 1615–1669). Elsevier Science: Amsterdam.
Engen, E., & Hubbard, G. (2005). Federal Government Debt and Interest Rates. In M. Gertler, & K. Rogoff (Eds.), NBER Macroeconomics Annual 2004 (pp. 83–160). MIT Press: Cambridge, MA.
Engle, R. F. (1982). Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation. Econometrica, 50, 987–1007. doi:10.2307/1912773
Forni, L., Monteforte, L., & Sessa, L. (2009). The General Equilibrium Effects of Fiscal Policy: Estimates for the Euro Area. Journal of Public Economics, 93, 559–585. doi:10.1016/j.jpubeco.2008.09.010
Gale, W. G., & Orszag, P. R. (2004). Budget Deficits, National Saving, and Interest Rates. Brookings Papers on Economic Activity, 35, 101–210. doi:10.1353/eca.2005.0007
Godfrey, L. G. (1978). Testing Against General Autoregressive and Moving Average Error Models when the Regressors Include Lagged Dependent Variables. Econometrica, 46, 1293–1301. doi:10.2307/1913829
Godfrey, L. G. (1988). Misspecification Test in Econometrics. Cambridge: Cambridge University Press.
Gould, J. P. (1968). Adjustment Costs in the Theory of Investment of the Firm. Review of Economic Studies, 35, 47–55. doi:10.2307/2974406
Granger, C. W. (1986). Developments in the Study of Cointegrated Economic Variables. Oxford Bulletin of Economics and Statistics, 48, 213–218. doi:10.1111/j.1468-0084.1986.mp48003002.x
Hansen, B. E. (1992). Efficient Estimation and Testing of Cointegrating Vectors in the Presence of Deterministic Trends. Journal of Econometrics, 53, 87–121. doi:10.1016/0304-4076(92)90081-2
Hansen, H., & Juselius, K. (1995). CATS in RATS Cointegration Analysis of Time Series. Evanston, IL: Estima.
Hercowitz, Z. (1986). The Real Interest Rate and Aggregate Supply. Journal of Monetary Economics, 18, 121–145. doi:10.1016/0304-3932(86)90072-3
Jarque, C. M., & Bera, A. K. (1987). A Test for Normality of Observations and Regression Residuals. International Statistical Review, 55, 167–172. doi:10.2307/1403192
Johansen, S. (1995). Identifying Restrictions of Linear Equations With Applications to Simulations Equations and Cointegration. Journal of Econometrics, 69, 111–32. doi:10.1016/0304-4076(94)01664-L
Johansen, S. (1995). Likelihood-Based Inference in Cointegrated Vector Autoregressive Models. Oxford University Press, Oxford.
Johansen, S. (2000). A Bartlett Correction Factor for Test on the Cointegration Relations. Econometric Theory, 16, 740–78. doi:10.1017/S0266466600165065
Johansen, S. (2002). A Small Sample Correction of the Test of Cointegrating Rank in the Vector Autoregressive Model. Econometrica, 70, 1929–1961. doi:10.1111/1468-0262.00358
Johansen, S., & Juselius, K. (1992). Testing Structural Hypotheses in a Multivariate Cointegration Analysis of the PPP and the UIP for UK. Journal of Econometrics, 53, 211–244. doi:10.1016/0304-4076(92)90086-7
Kameda, K. (2014). Budget Deficits, Government Debt, and Long-term Interest Rates in Japan. Journal of the Japanese and International Economies, 32, 105–124. doi:10.1016/j.jjie.2014.02.001
Laubach, T. (2009). New Evidence on the Interest Rate Effects of Budget Deficits and Debt. Journal of the European Economic Association, 7, 858–885. doi:10.1162/JEEA.2009.7.4.858
Lee, J., & Strazicich, M. C. (2001). Break Point Estimation and Spurious Rejections with Endogenous Unit Root Tests. Oxford Bulletin of Economics and Statistics, 63, 535–558. doi:10.1111/1468-0084.00234
Lee, J., & Strazicich, M. C. (2003). Minimum Lagrange Multiplier Unit Root Test with Two Structural Breaks. The Review of Economics and Statistics, 85, 1082–1089. doi:10.1162/003465303772815961
Leeper, E. M., Plante, M., & Traum, N. (2010). Dynamics of Fiscal Financing in the United States. Journal of Econometrics, 156, 304–321. doi:10.1016/j.jeconom.2009.11.001
Link, S. B. (2006). Do Government Purchases Crowd out Investment? International Review of Economics, 53, 323–333. doi:10.1007/BF03029784
Lucas, R. E. (1967). Adjustment Costs and the Theory of Supply. The Journal of Political Economy, 75, 321–334. doi:10.1086/259289
Phillips, P. C., & Hansen, B. E. (1990). Statistical Inference in Instrumental Variables Regression with I(1) Processes. The Review of Economic Studies, 57, 99–125. doi:10.2307/2297545
Ramey, V. A. (2019). Ten Years after the Financial Crisis: What Have We Learned from the Renaissance in Fiscal Research? Journal of Economic Perspectives, 33, 89–114. doi:10.1257/jep.33.2.89
Ramsey, J. B. (1969). Tests for Specification Errors in Classical Linear Least-Squares Regression Analysis. Journal of Royal Statistical Society, Series B, 31, 350–371. doi:10.1111/j.2517-6161.1969.tb00796.x
Ratto, M., Roeger, W., & Veld, J. I. (2009). QUEST III: An Estimated Open-Economy DSGE Model of the Euro Area with Fiscal and Monetary Policy. Econometric Modelling, 26, 222–233. doi:10.1016/j.econmod.2008.06.014
Rothschild, M. (1971). On the Cost of Adjustment. The Quarterly Journal of Economics, 85, 605–622. doi:10.2307/1882270
Salotti, S., & Trecroci, C. (2016). The Impact of Government Debt, Expenditure and Taxes on Aggregate Investment and Productivity Growth. Economica, 83, 356–384. doi:10.1111/ecca.12175
Scarth, W. M. (1984). Adjustment Costs and Aggregate Supply Theory. Canadian Journal of Economics, 17, 847–854. doi:10.2307/135077
Söderström, H. T. (1976). Production and Investment Under Costs of Adjustment A Survey. Zeitschrift für Nationalökonomie, 36, 369–388. doi:10.1007/BF01287519
Traum, N., & Yang, S.-C. S. (2015). When Does Government Debt Crowd Out Investment? Journal of Applied Econometrics, 30, 24–45. doi:10.1002/jae.2356
Treadway, A. B. (1970). Adjustment Costs and Variable Inputs in the Theory of the Competitive Firm. Journal of Economic Theory, 2, 329–347. doi:10.1016/0022-0531(70)90017-7
Uhlig, H. (2010). Some Fiscal Calculus. American Economic Review, 100, 30–34. doi:10.1257/aer.100.2.30
White, H. (1980). A Heteroskedasticity Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity. Econometrica, 48, 817–837. doi:10.2307/1912934
Wisley, T. O., & Johnson, S. R. (1985). An Evaluation of Alternative Investment Hypotheses using Non-Nested Tests. Southern Economic Journal, 52, 422-430. doi:10.2307/1059628
Zivot, E., & Andrews, D. W. (1992). Further Evidence on the Great Crash, the Oil Price Shock, and the Unit-Root Hypothesis. Journal of Business and Economic Statistics, 10, 3851–74. doi:10.2307/1391541
Afonso, A., & St. Aubyn, M. (2009). Macroeconomic Rates of Return of Public and Private Investment: Crowding-In and Crowding-Out Effects. The Manchester School, 77(Supplement), 21–39. doi:10.1111/j.1467-9957.2009.02117.x
Ahmed, S. (1986). Railway Reforms: Do They Influence Operating Efficiency? Journal of Monetary Economics, 17, 197–224. doi:10.1016/0304-3932(86)90028-0
Alesina, A., Ardagna, S., Perotti, R., & Schiantarelli, F. (2002). Fiscal Policy, Profits, and Investment. American Economic Review, 92, 571–589. doi:10.1257/00028280260136255
Allen, R. G. (1967). Macro-Economic Theory. London, The Macmillan Press Ltd.
Ardagna, S., Caselli, F., & Lane, T. (2007). Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries. The B.E. Journal of Macroeconomics, 7, 1-33. doi:10.2202/1935-1690.1417
Aschauer, D. A. (1989). Does Public Capital Crowd Out Private Capital? Journal of Monetary Economic, 24, 171–188. doi:10.1016/0304-3932(89)90002-0
Azzimonti, M., De Francisco, E., & Quadrini, V. (2014). Financial Globalization, Inequality, and the Rising Public Debt. American Economic Review, 104, 2267–2302. doi:10.1257/aer.104.8.2267
Bai, J., & Perron, P. (2003). Computation and Analysis of Multiple Structural Change Models. Journal of Applied Econometrics, 18, 1–22. doi:10.1002/jae.659
Barro, R. J. (1981). Output Effects of Government Purchases. Journal of Political Economy, 89, 1086–1121. doi:10.1086/261024
Barth, J. R., Iden, G., Russek, F. S., & Wohar, M. (1991). The Effects of Federal Budget Deficits on Interest Rates and the Composition of Domestic Output. In R. G. Penner (Ed.), The Great Fiscal Experiment (pp. 71–141). The Urban Institute Press: Washington, DC.
Bernanke, B. S. (1983). Irreversibility, Uncertainty, and Cyclical Investment. The Quarterly Journal of Economics, 98, 85–106. doi:10.2307/1885568
Blackley, P. R. (2014). New Estimates of Direct Crowding out (or in) of Investment and of a Peace Dividend for the U.S. Economy. Journal of Post Keynesian Economics, 37, 67–90. doi:10.2753/PKE0160-3477370106
Brechling, F. (1975). Investment and Employment Decisions. Manchester, Manchester University Press.
Cheung, Y.-W., & Lai, K. S. (1993). Finite Sample Sizes of Johansen's Likelihood Ratio Tests for Cointegration. Oxford Bulletin of Economics and Statistics, 55, 313–328. doi:10.1111/j.1468-0084.1993.mp55003003.x
Chirinko, R. S., & Schaller, H. (1996). Bubbles, Fundamentals, and Investment: A Multiple Equation Testing Strategy. Journal of Monetary Economics, 38, 47–76. doi:10.1016/0304-3932(96)01267-6
Chow, G. C., & Lin, A. I. (1971). Best Linear Unbiased Interpolation, Distribution, and Extrapolation of Time Series by Related Series. The Review of Economics and Statistics, 53, 372–375. doi:10.2307/1928739
Claeys, P., Moreno, R., & Suriñach, J. (2012). Debt, Interest Rates, and Integration of Financial Markets. Economic Modelling, 29, 48–59. doi:10.1016/j.econmod.2011.05.009
Cogan, J. F., Cwik, T., Taylor, J. B., & Wieland, V. (2010). New Keynesian versus Old Keynesian Government Spending Multipliers. Journal of Economic Dynamics & Control, 34, 281–295. doi:10.1016/j.jedc.2010.01.010
Costrell, R. M. (1983). Profitability and Aggregate Investment under Demand Uncertainty. The Economic Journal, 93, 166–181. doi:10.2307/2232171
Desroches, B., & Francis, M. (2010). World Real Interest Rates: A Global Savings and Investment Perspective. Applied Economics, 42, 2801–2816. doi:10.1080/00036840801964690
Eisner, R., & Strotz, R. H. (1963). Determinants of Business Investment. In D. B. et al. (Ed.), Impacts of Monetary Policy (a series of research studies for the Commission on money and credit ed., pp. 59–338). Prentice-Hall.
Elmendorf, D., & Mankiw, N. G. (1999). Government Debt. In J. Taylor, & M. Woodford (Eds.), Handbook of Macroeconomics (pp. 1615–1669). Elsevier Science: Amsterdam.
Engen, E., & Hubbard, G. (2005). Federal Government Debt and Interest Rates. In M. Gertler, & K. Rogoff (Eds.), NBER Macroeconomics Annual 2004 (pp. 83–160). MIT Press: Cambridge, MA.
Engle, R. F. (1982). Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation. Econometrica, 50, 987–1007. doi:10.2307/1912773
Forni, L., Monteforte, L., & Sessa, L. (2009). The General Equilibrium Effects of Fiscal Policy: Estimates for the Euro Area. Journal of Public Economics, 93, 559–585. doi:10.1016/j.jpubeco.2008.09.010
Gale, W. G., & Orszag, P. R. (2004). Budget Deficits, National Saving, and Interest Rates. Brookings Papers on Economic Activity, 35, 101–210. doi:10.1353/eca.2005.0007
Godfrey, L. G. (1978). Testing Against General Autoregressive and Moving Average Error Models when the Regressors Include Lagged Dependent Variables. Econometrica, 46, 1293–1301. doi:10.2307/1913829
Godfrey, L. G. (1988). Misspecification Test in Econometrics. Cambridge: Cambridge University Press.
Gould, J. P. (1968). Adjustment Costs in the Theory of Investment of the Firm. Review of Economic Studies, 35, 47–55. doi:10.2307/2974406
Granger, C. W. (1986). Developments in the Study of Cointegrated Economic Variables. Oxford Bulletin of Economics and Statistics, 48, 213–218. doi:10.1111/j.1468-0084.1986.mp48003002.x
Hansen, B. E. (1992). Efficient Estimation and Testing of Cointegrating Vectors in the Presence of Deterministic Trends. Journal of Econometrics, 53, 87–121. doi:10.1016/0304-4076(92)90081-2
Hansen, H., & Juselius, K. (1995). CATS in RATS Cointegration Analysis of Time Series. Evanston, IL: Estima.
Hercowitz, Z. (1986). The Real Interest Rate and Aggregate Supply. Journal of Monetary Economics, 18, 121–145. doi:10.1016/0304-3932(86)90072-3
Jarque, C. M., & Bera, A. K. (1987). A Test for Normality of Observations and Regression Residuals. International Statistical Review, 55, 167–172. doi:10.2307/1403192
Johansen, S. (1995). Identifying Restrictions of Linear Equations With Applications to Simulations Equations and Cointegration. Journal of Econometrics, 69, 111–32. doi:10.1016/0304-4076(94)01664-L
Johansen, S. (1995). Likelihood-Based Inference in Cointegrated Vector Autoregressive Models. Oxford University Press, Oxford.
Johansen, S. (2000). A Bartlett Correction Factor for Test on the Cointegration Relations. Econometric Theory, 16, 740–78. doi:10.1017/S0266466600165065
Johansen, S. (2002). A Small Sample Correction of the Test of Cointegrating Rank in the Vector Autoregressive Model. Econometrica, 70, 1929–1961. doi:10.1111/1468-0262.00358
Johansen, S., & Juselius, K. (1992). Testing Structural Hypotheses in a Multivariate Cointegration Analysis of the PPP and the UIP for UK. Journal of Econometrics, 53, 211–244. doi:10.1016/0304-4076(92)90086-7
Kameda, K. (2014). Budget Deficits, Government Debt, and Long-term Interest Rates in Japan. Journal of the Japanese and International Economies, 32, 105–124. doi:10.1016/j.jjie.2014.02.001
Laubach, T. (2009). New Evidence on the Interest Rate Effects of Budget Deficits and Debt. Journal of the European Economic Association, 7, 858–885. doi:10.1162/JEEA.2009.7.4.858
Lee, J., & Strazicich, M. C. (2001). Break Point Estimation and Spurious Rejections with Endogenous Unit Root Tests. Oxford Bulletin of Economics and Statistics, 63, 535–558. doi:10.1111/1468-0084.00234
Lee, J., & Strazicich, M. C. (2003). Minimum Lagrange Multiplier Unit Root Test with Two Structural Breaks. The Review of Economics and Statistics, 85, 1082–1089. doi:10.1162/003465303772815961
Leeper, E. M., Plante, M., & Traum, N. (2010). Dynamics of Fiscal Financing in the United States. Journal of Econometrics, 156, 304–321. doi:10.1016/j.jeconom.2009.11.001
Link, S. B. (2006). Do Government Purchases Crowd out Investment? International Review of Economics, 53, 323–333. doi:10.1007/BF03029784
Lucas, R. E. (1967). Adjustment Costs and the Theory of Supply. The Journal of Political Economy, 75, 321–334. doi:10.1086/259289
Phillips, P. C., & Hansen, B. E. (1990). Statistical Inference in Instrumental Variables Regression with I(1) Processes. The Review of Economic Studies, 57, 99–125. doi:10.2307/2297545
Ramey, V. A. (2019). Ten Years after the Financial Crisis: What Have We Learned from the Renaissance in Fiscal Research? Journal of Economic Perspectives, 33, 89–114. doi:10.1257/jep.33.2.89
Ramsey, J. B. (1969). Tests for Specification Errors in Classical Linear Least-Squares Regression Analysis. Journal of Royal Statistical Society, Series B, 31, 350–371. doi:10.1111/j.2517-6161.1969.tb00796.x
Ratto, M., Roeger, W., & Veld, J. I. (2009). QUEST III: An Estimated Open-Economy DSGE Model of the Euro Area with Fiscal and Monetary Policy. Econometric Modelling, 26, 222–233. doi:10.1016/j.econmod.2008.06.014
Rothschild, M. (1971). On the Cost of Adjustment. The Quarterly Journal of Economics, 85, 605–622. doi:10.2307/1882270
Salotti, S., & Trecroci, C. (2016). The Impact of Government Debt, Expenditure and Taxes on Aggregate Investment and Productivity Growth. Economica, 83, 356–384. doi:10.1111/ecca.12175
Scarth, W. M. (1984). Adjustment Costs and Aggregate Supply Theory. Canadian Journal of Economics, 17, 847–854. doi:10.2307/135077
Söderström, H. T. (1976). Production and Investment Under Costs of Adjustment A Survey. Zeitschrift für Nationalökonomie, 36, 369–388. doi:10.1007/BF01287519
Traum, N., & Yang, S.-C. S. (2015). When Does Government Debt Crowd Out Investment? Journal of Applied Econometrics, 30, 24–45. doi:10.1002/jae.2356
Treadway, A. B. (1970). Adjustment Costs and Variable Inputs in the Theory of the Competitive Firm. Journal of Economic Theory, 2, 329–347. doi:10.1016/0022-0531(70)90017-7
Uhlig, H. (2010). Some Fiscal Calculus. American Economic Review, 100, 30–34. doi:10.1257/aer.100.2.30
White, H. (1980). A Heteroskedasticity Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity. Econometrica, 48, 817–837. doi:10.2307/1912934
Wisley, T. O., & Johnson, S. R. (1985). An Evaluation of Alternative Investment Hypotheses using Non-Nested Tests. Southern Economic Journal, 52, 422-430. doi:10.2307/1059628
Zivot, E., & Andrews, D. W. (1992). Further Evidence on the Great Crash, the Oil Price Shock, and the Unit-Root Hypothesis. Journal of Business and Economic Statistics, 10, 3851–74. doi:10.2307/1391541