Leveraging interest-growth differentials: hidden effects of government financial assets in the European Union
Keywords:
Public debt, Financial assets, QARDL, ARDL, PMGAbstract
PurposeGiven that government financial assets represent a large proportion of gross debt accumulation, this study examines their impact on debt leveraging and potential returns on the gap between interest rates and economic growth (r-g).
Design/methodology/approachThis research focuses on the co-movements of r-g differentials, government financial assets and the primary deficit through a channel of gross debt, investment, external balance and ratings, using a sample of 27 European Union economies from 2000 to 2022. The following co-integration methods were estimated: (1) for the aggregate, panel quantile autoregressive distributed lags (QARDL), ARDL- pooled mean group (PMG) for panel data, implemented with a (PMG) and (2) ARDL-error correction (EC) for individual countries at a granular level.
FindingsWhile government financial assets drive short- and long-run debt trajectories, granular country heterogeneities reveal differentiated results for financial assets leveraging potential returns on the differential between interest rates and output growth (r-g). Government financial assets may enhance r-g, but may risk even undermining gains from primary deficit consolidation efforts. By comparing aggregate estimations with country granular approaches, outliers from non-statistically significant estimations reveal the epistemological limits of aggregation, statistics and probability theory, warning against overconfidence in such mere guidance tools, which are not safeguarding guarantees.
Research limitations/implicationsStatistical asymptotics and instability of non-independent and identical distributions may underestimate variance. Furthermore, skewness and leptokurtosis may benefit from extreme value theory. In addition, technological changes, policy regimes, geopolitical events and economic crises can change in-built long-run relationships.
Practical implicationsHeterogeneity of government financial assets effects depend on socio and macrofinance conditions, advocating the principle of subsidiarity. Financial assets, such as sovereign wealth funds linked to natural resources, oil in Norway, copper in Chile, may benefit from financial assets assessments. The strengthening of democratic accountability calls for transparency about financial assets contribution to debt trajectories, r-g effects and risks of potential undermining primary deficit consolidations. Accounting reporting should appropriately disclose changes in assets value from exposition to market volatility, accumulation of holding costs due to constraints to asset liquidation, due to non-active secondary markets, or long investment horizons.
Social implicationsTo strengthen democratic accountability, there should be transparency about their contribution to debt trajectories, r-g effects and risks to potential undermining primary deficit consolidation. Their performance depends on financial markets and socio- and macro-finance conditions, calling for the principle of subsidiarity.
Originality/valueRather than the traditional emphasis on government debt, this study examines the leverage effect on the gap between interest rates and economic growth (r-g differential). While the literature primarily addresses stock-flow adjustments (SFAs), the focus is narrowed to financial assets underlying government interventions on the supply side of the economy. Evidence is provided on the risks of financial assets undermining primary deficit consolidation efforts. While the literature highlights the short and medium terms, estimates are divided into short-term dynamics and hypothetical in-built long-run cointegrations. Panel aggregation is compared with granular estimates, uncovering heterogeneities and supporting governance subsidiarity. Support for statistical pluralism is provided by comparing results and methodological limitations.
Downloads
References
Abbas, S.A., Pienkowski, A. and Rogoff, K. (2020), Sovereign Debt: A Guide for Economists and Practitioners, Oxford University Press, Oxford, doi: https://doi.org/10.1093/oso/9780198850823.001.0001.
Abbas, S.M.A., Belhocine, N., El-Ganainy, A. and Horton, M. (2011), “Historical patterns and dynamics of public debt: evidence from a new database”, IMF Economic Review, Vol. 59 No. 4, pp. 717-742, doi: https://doi.org/10.1057/imfer.2011.24.
Acosta-Ormaechea, S. (2020), “Public debt dynamics and intra-year exchange rate fluctuations”, Working paper No. 20/261, IMF, Washington D.C., doi: https://doi.org/10.5089/9781513561585.001.
Afonso, A. and Alves, J. (2019), “Short and long-term interest rate risk: the sovereign balance-sheet nexus”, Finance Research Letters, Vol. 31, pp. 294-299, doi: https://doi.org/10.1016/j.frl.2018.11.014.
Afonso, A. and Coelho, J.C. (2023), “Twin deficits through the looking glass: time-varying analysis in the Euro area”, Economic Change and Restructuring, Vol. 56 No. 4, pp. 2087-2110, doi: https://doi.org/10.1007/s10644-023-09534-4.
Afonso, A. and Jalles, J.T. (2020), “Stock flow adjustments in sovereign debt dynamics: the role of fiscal frameworks”, International Review of Economics and Finance, Vol. 65, pp. 1-16, doi: https://doi.org/10.1016/j.iref.2019.09.007.
Afonso, A., Alves, J. and Tovar, J. (2021), “Fiscal reaction functions in the EU: a tale of “r-g” and whether it matters”, Revue Française d'Economie, Vol. XXXVI, pp. 65-101, doi: https://doi.org/10.3917/rfe.213.0065.
Alesina, A., Favero, C. and Giavazzi, F. (2019), Austerity: When it Works and When it Doesn't, Princeton University Press, Princeton, doi: https://doi.org/10.2307/j.ctvc77f4b.
Alt, J., Lassen, D.D. and Wehner, J. (2014), “It isn't just about Greece: domestic politics, transparency and fiscal gimmickry in Europe”, British Journal of Political Science, Vol. 44 No. 4, pp. 707-716, doi: https://doi.org/10.1017/S0007123414000064.
Arshed, N., Nasir, S. and Saeed, M. (2022), “Impact of the external debt on standard of living: a case of Asian countries”, Social Indicators Research: An International and Interdisciplinary Journal for Quality-of-Life Measurement, Vol. 163 No. 1, p. 321-340, August, doi: https://doi.org/10.1007/s11205-022-02906-9.
Barro, R.J. (1979), “On the determination of the public debt”, Journal of Political Economy, Vol. 87 No. 5, pp. 940-971, doi: https://doi.org/10.1086/260807.
Bhandari, A., Evans, D., Golosov, M. and Sargent, T.J. (2017), “Fiscal policy and debt management with incomplete markets”, The Quarterly Journal of Economics, Vol. 132 No. 2, pp. 617-663, doi: https://doi.org/10.1093/qje/qjw041.
Bohn, H. (1995), “The sustainability of budget deficits in a stochastic economy”, Journal of Money, Credit, and Banking, Vol. 27 No. 1, pp. 257-271, doi: https://doi.org/10.2307/2077862.
Bohn, H. (1998), “The behavior of U.S. public debt and deficits”, Quarterly Journal of Economics, Vol. 113 No. 3, pp. 949-963, doi: https://doi.org/10.1162/003355398555793.
Brunnermeier, M.K., Merkel, S. and Sannikov, Y. (2022), “Debt as a safe asset”, Working paper No. 29626, NBER, doi: https://doi.org/10.2139/ssrn.4004839.
Buchanan, J.M. (1999 [1967]), The Collected Works of James M. Buchanan, Vol. 4. Public Finance in Democratic Process: Fiscal Institutions and Individual Choice, Liberty Fund, Indianapolis, [PubMed].
Castle, J.L., Doornik, J.A. and Hendry, D.F. (2021), “Modelling non-stationary big data”, International Journal of Forecasting, Vol. 37 No. 4, pp. 1556-1575, doi: https://doi.org/10.1016/j.ijforecast.2020.08.002.
Cho, J.S., Kim, T.H. and Shin, Y. (2015), “Quantile cointegration in the autoregressive distributed-lag modelling framework”, Journal of Econometrics, Vol. 188 No. 1, pp. 281-300, doi: https://doi.org/10.1016/j.jeconom.2015.05.003.
Dawar, I., Dutta, A., Bouri, E. and Saeed, T. (2021), “Crude oil prices and clean energy stock indices: lagged and asymmetric effects with quantile regression”, Renewable Energy, Vol. 163, pp. 288-299, doi: https://doi.org/10.1016/j.renene.2020.08.162.
Debrun, X., Ostry, J.D., Willems, T. and Wyplosz, C. (2020), “Debt sustainability”, in Abbas, S.A., Pienkowski, A. and Rogoff, K. (Eds), Sovereign Debt: A Guide for Economists and Practitioners, Oxford University Press, pp. 151-191, doi: https://doi.org/10.1093/oso/9780198850823.001.0001.
Eichengreen, B., El-Ganainy, A., Esteves, R. and Mitchener, K.J. (2019), Public debt through the ages, working paper No. 25494, NBER, Massachusetts: National Bureau of Economic Research, doi: https://doi.org/10.3386/w25494.
Ellison, M. and Scott, A. (2020), “Managing the UK national debt 1694-2018”, American Economic Journal: Macroeconomics, Vol. 12 No. 3, pp. 227-257, doi: https://doi.org/10.1257/mac.20180263.
Friedman, M. (1962, 2016), “Capitalism and freedom in democracy: a reader”, in Blaug, R. and Schwarzmantel, J. (Eds), New York Chichester, Columbia University Press, West Sussex, pp. 344-349, doi: https://doi.org/10.7312/blau17412-074.
Galbraith, J.K. (1958), The Affluent Society, Houghton Mifflin Harcourt, Boston, [PubMed], 0547575793.
Godley, W. and Lavoie, M. (2007), Monetary Economics. An Integrated Approach to Credit, Money, Income, Production and Wealth, Palgrave Macmillan UK, London, doi: https://doi.org/10.1007/978-1-137-08599-3.
Hall, G.J. and Sargent, T.J. (2011), “Interest rate risk and other determinants of post-WWII US government debt/GDP dynamics”, American Economic Journal: Macroeconomics, Vol. 3, pp. 192-214, doi: https://doi.org/10.1257/mac.3.3.192.
Hamilton, J.D. and Flavin, M.A. (1986), “On the limitations of government borrowing: a framework for empirical testing”, American Economic Review, Vol. 76 No. 4, pp. 808-819, doi: https://doi.org/10.3386/w1632.
Jalles, J. and Medas, P. (2022), “Economic growth after debt surges”, Working paper series, 2022/159, IMF, Washington DC, doi: https://doi.org/10.5089/9798400217227.001.
Jaramillo, L., Mulas-Granados, C. and Jalles, J.T. (2017a), “Debt spikes, blind spots, and financial stress”, International Journal of Finance and Economics, Vol. 22 No. 4, pp. 421-437, doi: https://doi.org/10.1002/ijfe.1598.
Jaramillo, L., Mulas-Granados, C. and Kimani, E. (2017b), “Debt spikes and stock flow adjustments: emerging economies in perspective”, Journal of Economics and Business, Vol. 94, pp. 1-14, doi: https://doi.org/10.1016/j.jeconbus.2017.08.003.
Keynes, J.M. (1936, 2018), The General Theory of Employment Interest and Money, Palgrave Macmillan, London, doi: https://doi.org/10.1007/978-3-319-70344-2.
Lütkepohl, H. and Krätzig, M. (2004), Applied Time Series Econometrics, Cambridge University Press, Cambridge, pp. 89-152, doi: https://doi.org/10.1017/CBO9780511606885.
Mankiw, N.A., Romer, D. and Weil, D.N. (1992), “A contribution to the empirics of economic growth”, The Quarterly Journal of Economics, Vol. 107 No. 2, pp. 407-437, doi: https://doi.org/10.2307/2118477.
Milesi-Ferretti, G.M. and Moriyama, K. (2006), “Fiscal adjustment in EU countries: a balance sheet approach”, Journal of Banking and Finance, Vol. 30 No. 12, pp. 3281-3298, doi: https://doi.org/10.1016/j.jbankfin.2006.05.010.
Perla, J., Christopher, T. and Michael, E.W. (2021), “Equilibrium technology diffusion, trade, and growth”, American Economic Review, Vol. 111 No. 1, pp. 73-128, doi: https://doi.org/10.1257/aer.20151645.
Pesaran, M.H., Shin, Y. and Smith, R.P. (1999), “Pooled mean group estimation of dynamic heterogeneous panels”, Journal of the American Statistical Association, Vol. 94 No. 446, pp. 621-634, doi: https://doi.org/10.2307/2670182.
Reischmann, M. (2016), “Creative accounting and electoral motives: evidence from OECD countries”, Journal of Comparative Economics, Vol. 44 No. 2, pp. 243-257, doi: https://doi.org/10.1016/j.jce.2015.07.001.
Romer, C. and Romer, D. (2019), “Fiscal space and the aftermath of financial crises: how it matters and why”, Brookings papers on economic activity, Working paper 25768, doi: https://doi.org/10.3386/w25768.
Seiferling, M. (2013), “Stock-flow adjustments, government’s integrated balance sheet and fiscal transparency”, Working paper 13/63, IMF, doi: https://doi.org/10.5089/9781475537642.001.
Selmi, R., Mensi, W., Hammoudeh, S. and Bouoiyour, J. (2018), “Is bitcoin a hedge, a safe haven or a diversifier for oil price movements? A comparison with gold”, Energy Economics, Vol. 74, pp. 787-801, doi: https://doi.org/10.1016/j.eneco.2018.07.007.
Solow, R. (1956), “A contribution to the theory of economic growth”, The Quarterly Journal of Economics, Vol. 70 No. 1, pp. 65-94, doi: https://doi.org/10.2307/1884513.
von Hagen, J. and Wolff, G.B. (2006), “What do deficits tell us about debt? Empirical evidence on creative accounting with fiscal rules in the EU”, Journal of Banking and Finance, Vol. 30 No. 12, pp. 3259-3279, doi: https://doi.org/10.1016/j.jbankfin.2006.05.011.
Weber, A. (2012), “Stock-flow adjustments and fiscal transparency: a cross country comparison”, Working paper 12/49, IMF. doi: https://doi.org/10.5089/9781463933821.001.
Wooldridge, J.M. (2010), Econometric Analysis of Cross Section and Panel Data, MIT Press, Cambridge, MA,
