Luận án tiến sĩ tài chính ngân hàng: Asymmetric impact of public debt on economic growth - empirical evidence from Vietnam

HOCHIMINH UNIVERSITY OF BANKING

NGUYEN XUAN DUNG

ASYMMETRIC IMPACT OF PUBLIC DEBT ON

ECONOMIC GROWTH – EMPIRICAL EVIDENCE FROM VIETNAM

DOCTORAL DISSERTATION OF FINANCE AND BANKING

HO CHI MINH CITY - 2024

MINISTRY OF EDUCATION AND TRAINING THE STATE BANK OF VIETNAM HOCHIMINH UNIVERSITY OF BANKING

NGUYEN XUAN DUNG

ASYMMETRIC IMPACT OF PUBLIC DEBT ON

ECONOMIC GROWTH - EMPIRICAL EVIDENCE FROM VIETNAM

DOCTORAL DISSERTATION OF FINANCE AND BANKING

Major: Finance - Banking CODE: 9.34.02.01

PhD Supervisor: Assoc Prof Dr Nguyen Duc Trung

HO CHI MINH CITY - 2024

DECLARATION OF ORIGINALITY

I am Nguyen Xuan Dung, a PhD student of Course 23, Academic Year 2019–2022, and I hereby declare that the research work is entirely my own original work under the guidance and supervision of Assoc Prof Dr Nguyen Duc Trung I affirm that this work has not been previously submitted to any other institution or organization for any academic or professional qualification I acknowledge and properly cite all the sources used in this work, ensuring that all information, data, and materials are accurate, reliable, and appropriately referenced I take full responsibility for the authenticity, originality, and integrity of the content presented in this work

Ho Chi Minh City, day month year Author

ACKNOWLEDGMENT

I would like to express my deepest gratitude to the individuals and institutions who have played a crucial role in the completion of this doctoral thesis First and foremost, my sincere appreciation goes to my esteemed supervisor, Assoc Prof Dr Nguyen Duc Trung, for his unwavering guidance, exceptional mentorship, and valuable insights throughout this research journey His expertise and dedication have been invaluable in shaping the trajectory and quality of this study

I am immensely grateful to the members of my doctoral committee for their invaluable feedback, constructive criticism, and rigorous evaluation Their scholarly contributions have significantly enhanced the intellectual rigor and academic merit of this thesis I would like to extend my heartfelt thanks to the faculty and staff of Postgraduate Education at Ho Chi Minh University of Banking for providing a conducive academic environment, access to resources, and opportunities for intellectual growth Their support has been instrumental in the successful completion of this research

Lastly, I wish to acknowledge the contributions of the countless researchers, scholars, and authors whose works have paved the way for this study Their groundbreaking research and seminal publications have provided the foundation upon which this thesis is built.

Ho Chi Minh City, day month year Author

SUMMARY OF THESIS

The thesis explores the relationship between fiscal policy, public debt, and economic growth in the context of Vietnam It explores the various fiscal policy strategies used by developed and developing countries, highlighting countercyclical policies in developed nations and procyclical policies in developing nations The primary aim of the study is to assess the impact of public debt on economic growth in Vietnam, analyzing the determinants of fiscal policy and their influence on economic outcomes

Using quarterly data from 2000 to 2021, the researchers employ regression models to examine the effects of fiscal policy decisions on Vietnam's economic performance The study's significance lies in its application of theoretical foundations to the specific context of Vietnam, providing empirical evidence to inform policy development related to public debt management The study yields several noteworthy results First, it confirms the prevailing pattern of procyclical fiscal policy in Vietnam, with increased government spending during economic upswings and reduced spending during downturns This cyclicality can pose challenges to sustainable economic growth, as fiscal policy is not effectively counteracting economic fluctuations Second, the analysis reveals a non-linear relationship between public debt and economic growth in Vietnam While a moderate level of debt can be conducive to economic expansion, excessively high levels of debt can hamper growth and stability Therefore, it is crucial to identify the threshold at which increasing debt levels become detrimental to economic performance Third, the study uncovers specific determinants of fiscal policy that significantly influence economic outcomes in Vietnam These determinants include government revenue, expenditure, and borrowing The findings suggest that policymakers should focus on optimizing these factors to achieve sustainable economic growth and prudent debt management

Building on these results, the content proposes new avenues for research One potential area of investigation is the exploration of alternative fiscal policy frameworks that could better align with Vietnam's economic context For example, the study suggests examining the feasibility and effectiveness of adopting a more

countercyclical fiscal policy approach in Vietnam to mitigate the negative impacts of economic fluctuations and promote stability Furthermore, the content emphasizes the importance of assessing the quality and composition of public expenditure It suggests investigating the allocation of government spending in sectors such as infrastructure, education, and healthcare to ensure that public resources are utilized efficiently and effectively Such research could shed light on the areas where targeted investments can yield the greatest economic returns and long-term development benefits In terms of policy recommendations, the study highlights the need for prudent debt management in Vietnam It emphasizes the importance of implementing fiscal reforms that aim to maintain a sustainable debt-to-GDP ratio This can be achieved through measures such as enhancing revenue collection, improving expenditure efficiency, and exploring innovative financing mechanisms

Additionally, the study underscores the significance of strengthening fiscal institutions and governance frameworks Transparent and accountable public financial management systems can help minimize the risks associated with public debt accumulation, ensure effective utilization of resources, and enhance investor confidence in Vietnam's economy The study also suggests the establishment of a comprehensive debt monitoring mechanism to regularly assess and manage public debt levels This mechanism should consider both quantitative and qualitative factors, taking into account the potential risks and implications of debt accumulation for economic stability and growth

In conclusion, the thesis provides detailed insights into the relationship between fiscal policy, public debt, and economic growth in Vietnam It highlights the importance of adopting appropriate fiscal policy frameworks, managing public debt prudently, and optimizing government expenditure to achieve sustainable economic growth The study's results, along with the proposed areas for further research and policy recommendations, offer valuable guidance for policymakers in Vietnam as they navigate the complex dynamics of fiscal policy and debt management.

TABLE OF CONTENT

CHAPTER 1: INTRODUCTION OF THE RESEARCH 1

1.1 THE RATIONALE OF RESEARCH 1

1.2 RESEARCH OBJECTIVES 6

1.3 OBJECTS, SCOPE AND METHODOLOGY OF THE RESEARCH 7

1.4 THE SIGNIFICANE AND CONTRIBUTIONS OF THE RESEARCH 8

1.5 RESEARCH CONTENTS 9

CHAPTER 2: THEORIES AND LITERATURE REVIEW 11

2.1 THEORIES OF FISCAL POLICY AND BUSINESS CYCLE 11

2.1.1 Concepts relevant to the research problems 11

2.1.2 Theories of Fiscal Policy and Business Cycle 13

2.2 THEORETICAL OF PUBLIC DEBT AND ECONOMIC GROWTH 16

2.2.1 Theories of Public debt 16

2.2.2 Classical theories of public debt and economic growth 17

2.2.3 Neoclassical theories of public debt and economic growth 21

2.2.4 Modern monetary policy on the relationship between public debt and economic growth 24

2.2.5 Theories of the linear impact of public debt on economic growth 25

2.2.6 Theories of nonlinear effects of public debt on economic growth 29

2.3 RELEVANT EMPIRICAL STUDIES ON THE RELATIONSHIP BETWEEN FISCAL POLICY AND THE BUSINESS CYCLE 31

2.3.1 Literature review of procyclical fiscal policy 31

2.3.2 Literature review of the countercyclical fiscal policy 40

2.3.3 Literature review of representative variables for the economic cycle and fiscal policy 42

2.4 LITERATURE REVIEW BETWEEN PUBLIC DEBT AND ECONOMIC GROWTH 44

2.4.1 Literature review of the negative impact of public debt on economic growth 44

2.4.2 Literature review of the positive impact of public debt on economic growth 50

2.4.3 Literature review of the neutral effect of public debt on economic growth 52

2.4.4 Literature review of nonlinear effects of public debt on economic growth 53

2.5 THE BASIS OF DESIGNING EMPIRICAL RESEARCH MODEL 70

CHAPTER 3: RESEARCH METHODOLOGY 75

3.1 RESEARCH MODEL 75

3.1.1 VECM model 75

3.1.2 NARDL model 79

3.2 VARIABLES DESCRIPTIONS OF THE RESEARCH MODEL 83

3.2.1 The variables of the model of the relationship between fiscal policy and the business cycle 83

3.2.2 The variables of the model of public debt on economic growth 84

3.3 RESEARCH DATA 85

3.3.1 Research data of the model of the relationship between fiscal policy and the business cycle 85

3.3.2 Research data of the model of public debt on economic growth 86

CHAPTER 4: RESEARCH RESULTS AND DISCUSSION 88

4.1 EXAMINING THE RELATIONSHIP BETWEEN FISCAL POLICY AND THE BUSINESS CYCLE 88

4.1.1 Tests of the research model 88

4.1.2 Results of testing the relationship between fiscal policy and economic growth 92

4.2 EXAMINING THE IMPACT OF PUBLIC DEBT ON ECONOMIC GROWTH 96

4.2.1 Tests of the research model 96

REFERENCES I APPENDIX EXAMINING THE RELATIONSHIP BETWEEN FISCAL

POLICY AND THE BUSINESS CYCLE XXII

APPENDIX 1: STATIONARY TEST OF DATA SERIES XXII APPENDIX 2: COINTERGRATION TEST XXX APPENDIX 3: CAUSALITY TEST XXXI APPENDIX 4: LAG ORDER SELECTION CRITERIA XXXII APPENDIX 5: THE STABILITY TEST OF THE MODEL XXXIII APPENDIX 6: THE VECM XXXV APPENDIX 7: IMPULSE RESPONSE FUNCTION XXXVI APPENDIX 8:VARIANCE DECOMPOSTION XXXVII

APPENDIX EXAMINING THE IMPACT OF PUBLIC DEBT ON

ECONOMIC GROWTH XXXVIII

APPENDIX 1: UNIT ROOT TEST XXXVIII APPENDIX 2: DATA DESCRIPTION XLVIII APPENDIX 3: THE ECR TEST XLIX APPENDIX 4: THE NARDL MODEL L APPENDIX 5: THE BREUSCH TEST LI APPENDIX 6: THE LONG RUN AND BOUNDS TEST LII APPENDIX 7: THE RAMSEY TEST LIII APPENDIX 8: THE WALD TEST LIV APPENDIX 9: PLOT OF CUMULATIVE SUM OF RESIDUALS CUSUM LV APPENDIX 10: PLOT OF THE CUMULATIVE SUM OF SQUARES OF

RECURSIVE RESIDUALS (CUSUMSQ) LVI APPENDIX 11: PLOT OF ASYMMETRIC CUMULATIVE DYNAMIC

MULTIPLIER LVII

LIST OF GRAPHS AND FIGURES

FIGURE 2.1 THE RELATIONSHIP BETWEEN PUBLIC DEBT AND

ECONOMIC GROWTH 22

FUGURE 4.1 STABILITY TEST OF THE MODEL 92

FIGURE 4.2 THE IMPULSE RESPONSE FUNCTION OF EXP, TAX, LIA, GDP 94

FIGURE 4.3 PLOT OF CUMULATIVE SUM (CUSUM) RESIDUALS 103

FIGURE 4.4 PLOT OF ADJUSTED CUMULATIVE SUM (CUSUMSQ) RESIDUALS 104

FIGURE 4.5 ASYMMETRIC CUMULATIVE DYNAMIC MULTIPLIER GRAPH OF PUBLIC DEBT AND ECONOMIC GROWTH 105

FIGURE 4.6 ASYMMETRIC CUMULATIVE DYNAMIC MULTIPLIER OF USDVND EXCHANGE RATE ON ECONOMIC GROWTH 105

LIST OF TABLES

TABLE 2.1 SUMMARY OF EXPERIMENTAL STUDIES ON THE

ASYMMETRIC IMPACT OF PUBLIC DEBT ON ECONOMIC GROWTH 67

TABLE 3.1 SOURCES OF VARIABLES USED IN THE MODEL 83

TABLE 3.2 DESCRIPTION OF THE MODEL VARIABLES 84

TABLE 3.3 DESCRIPTIVE STATISTICS OF THE VARIABLES 85

TABLE 3.4 DESCRIPTIVE STATISTICS OF VARIABLES 86

TABLE 4.1 UNIT ROOT TEST OF DATA SERIES (D=0) 88

TABLE 4.2 UNIT ROOT TEST OF DATA SERIES (D=2) 89

TABLE 4.3 COINTEGRATION TEST OF DATA SERIES 89

TABLE 4.4 CAUSALITY TEST 90

TABLE 4.5 THE VECM 93

TABLE 4.6 VARIANCE DECOMPOSITION 95

TABLE 4.7 UNIT ROOT TEST OF DATA SERIES (D=0) 97

TABLE 4.8 UNIT ROOT TEST OF DATA SERIES (D=1) 97

TABLE 4.9 THE RAMSEY TEST 98

TABLE 4.10 THE BREUSCH/PAGAN TEST 99

TABLE 4.11 THE NARDL MODE 100

TABLE 4.12 NONLINEAR CO-INTEGRATION TEST 101

TABLE 4.13 SHORT-RUN AND LONG-RUN ASYMMETRY TESTING 101

TABLE 4.14 WALD TEST IN THE SHORT RUN AND THE LONG RUN 102

TABLE 4.15 ASYMMETRICAL IMPACT OF PUBLIC DEBT ON ECONOMIC GROWTH IN THE LONG-RUN 102

CHAPTER 1: INTRODUCTION OF THE RESEARCH 1.1 THE RATIONALE OF RESEARCH

A number of economies continue to experience below-average growth several years after the global financial crisis Medium-term growth projections have been revised downward since 2011, which indicates the uncertainty surrounding the outlook for medium-term economic growth Simultaneously, the ratio of public debt to GDP has skyrocketed in numerous developing market economies, reaching historic highs in a number of nations In this context, the question is how fiscal policy interacts with the economic growth cycle

The government uses monetary policy (money supply, interest rates, exchange rates, etc.) and fiscal policy (government spending, taxes, subsidies, etc.) to intervene in the economy during periods of recession or rapid growth Those policies are separated into pro-cyclical and counter-cyclical stages based on the recession or economic growth cycle A pro-cyclical fiscal policy is defined as one that aims to balance the government budget For instance, if there is a budget deficit, it is necessary to increase tax revenues and decrease government spending A fiscal strategy with the purpose of restoring output to its potential level is countercyclical To attain potential output levels during a recession, the government continues to increase government spending and cut tax receipts (Keynes, 1936)

Governments in developed nations frequently employ a countercyclical fiscal policy An expansionary fiscal policy during economic contraction and a contractionary fiscal policy during economic expansion can both explain this The implementation of countercyclical fiscal policy by developed nations uses automated stabilizing instruments When unemployment is high, unemployment insurance and social transfer payments are increased As declining personal income reduces government tax collection, tax policy can potentially reverse the cycle While the economy exhibits signals of contraction, expansionary fiscal policy is enacted (Acemoglu et al., 2013; Fatas and Mihov, 2013)

While macroeconomic policy in developed nations is primarily targeted at stabilizing the economic cycle, countercyclical fiscal policy is implemented to accumulate in the expansion period In developing nations, macroeconomic policy is procyclical Those economies frequently increase investment and public spending throughout the recovery phase of the economy to catch up with developing nations The government, particularly the local authorities, desires to increase spending when the economy is expanding Developing nations frequently lack automatic stabilization instruments during economic recessions For instance, unemployment insurance payouts are infrequent, and social transfers represent a negligible portion of the budget In developing nations, the majority of expenditures are comprised of government consumption and wages Additionally, indirect taxes (trade and consumption taxes) sometimes replace direct taxes in emerging countries (income taxes) In order for the government to achieve its long-term macroeconomic management objectives, it must employ fiscal policy effectively and at the appropriate moment during a recession or rapid economic expansion (Talvi and Vegh, 2005)

Through the use of fiscal policy, the government intervenes to restore economic equilibrium An unfavorable impact on the economy can have both immediate and long-term repercussions if the wrong decision is made Consequently, it is crucial to determine the most effective fiscal policy instruments required to support economic growth

In order to fund global government budgets and promote economic growth, sustainable funding policies are needed Frequently, when tax collections fall short of projected government spending, there is no other option than to increase taxes or borrow money either domestically or internationally (Owusu-Nantwi and Erickson, 2016) When governments employ borrowing as an alternative to taxation, this results in public debt (Ogunmuyiwa, 2011) Consequently, public debt consists of the government's short- and long-term loans used to support public expenditures due to insufficient public revenue As a result of the worldwide economic crisis following World War II, many economies (including wealthy and 174 emerging

nations) were forced to borrow locally or internationally to pay their budget deficits These efforts have led to the accumulation of public debt in many nations, causing economic recession and financial crises in the early 2000s in numerous developed and developing nations (Donayre and Taivan, 2017)

The government uses the public debt as a key tool to finance national development The use of debt to finance expenditures will ultimately increase productivity and stimulate the economy However, empirical research on public debt, such as that conducted by Reinhart and Rogoff (2010) and Panizza and Presbitero (2014), indicates that public debt will have a negative effect on economic growth once it exceeds a particular threshold According to Mankiw (2013), the government expenditure deficit is greater than the self-accumulation that domestic and foreign businesses can pay Public debt encompasses both international and domestic obligations Rahman (2012) defines public debt as a circumstance in which the quantity of valuable documents possessed by the government is insufficient to compensate for the deficiency in previous expenditures According to macroeconomic theory, public debt utilized to pay for spending in productive areas such as health, education, and nutrition will have a beneficial impact on economic growth (Freeman & Webber 2009)

The country will benefit from the debt that the government incurs and vice versa if the rate of return on public debt is higher than the rate at which the government receives payment for its services Presently, rising national debt is a global phenomenon Total public debt has long been cited as a major subject of concern by both financial and monetary policymakers Public debt, particularly debt spending programs, plays a vital role in achieving rapid economic growth According to Elmendorf and Mankiw (1999), debt can increase aggregate demand and output in the short term but lower capital and output in the long term Governments rely heavily on public debt to finance a nation's economic growth Debt is utilized to fund expenditures that will ultimately increase productivity and stimulate economic growth

It is extremely difficult for a nation to create a budget surplus; hence, public debt is unavoidable (Adom, 2016) However, unsustainable levels of public debt might inhibit economic growth (Adom, 2016) Unsustainable public debt hinders economic growth by reducing a country's competitiveness and increasing its financial markets' sensitivity to international shocks (Cochrane, 2011a; Castro et al., 2015) This also means that, while borrowing to support public spending is not necessarily a bad thing, it can have a negative influence on economic growth if it is not adequately controlled Weak debt management practices in low- and middle-income countries were the primary cause of the global debt crises of the 1970s and 1980s (Marquez, 2000) Due to a rise in short-term loans to finance long-term projects without the ability to meet debt commitments on time, debt collection and repayment have become a central concern for emerging and less developed countries (Marquez, 2000) There are still conflicting conclusions regarding how public debt affects economic growth, regardless of whether it rises or falls Others academics find a positive, some a negative, while others find no correlation between public debt and economic growth under different economic conditions According to economists, public debt is not a problem; rather, the issue is the debt's mismanagement Empirical evidence suggests that if adequate laws are in place and can be used to promote conditional lending, where aid is attached to policy reform, then aid will be successful On both the short- and long-term, public debt has a significant impact on the economy (Kumar and Woo, 2010) The mismatch between theory and practice on the relationship between public debt and economic growth has also contributed to the disparities in policy approaches among the examined nations

The effect of government fiscal policy on economic growth via debt, taxation, and expenditure continues to be a significant economic policy goal in global economies Various perspectives exist about the origins and consequences of foreign public debt on the economies of emerging nations Indeed, the occurrence of financial crises in both economically advanced and developing nations, along with significant disparities in economic growth rates among global economies, has resulted in varied connections regarding the influence of public debt on economic

growth Theoretical and empirical inconsistencies on the relationship between public debt and economic development have led to divergent policy approaches in the countries under examination Furthermore, it is important to note that public debt does not consistently have favorable effects on economic growth It is necessary to accurately quantify the detrimental effect of public debt on economic growth after it reaches a certain level

Currently, a rise in public debt frequently coincides with the global trend of economic growth in nations An ongoing worry among macroeconomic policymakers is the issue of aggregate public debt Debt expenditure plans play a crucial role in achieving fast economic growth while also reaping the benefits of public debt The relationship between public debt and economic growth remains a contentious subject, with diverse outcomes Various economic situations provide varying findings among academics about the correlation between public debt and economic growth Other researchers see a positive association, while others observe a negative one, and others discover no significant relationship at all Empirical evidence demonstrates that public debt has a significant impact on the economies of nations, both in the short and long term

Vietnam's national debt is thought to be under control, although it may still pose a barrier to its ambitions for economic growth High debt can significantly affect economic growth and development Thus, public debt has both beneficial and negative consequences for the economies of nations, causing several obstacles and difficulties High levels of debt might hinder economic growth and development This topic has always attracted a great deal of attention due to the difficulties involved in analyzing the challenges of economic growth and governmental debt The impact of government interventions on economic growth through debt, taxation, and spending continues to be an important subject of economic policy in the global economy Although the origins and effects of public debt on the economies of developing nations are still debatable, it is clear that public debt has a negative impact on economic growth Recent financial crises in both developed and developing nations, as well as vast disparities in economic growth rates among

world economies, have led to a new link between public debt and economic growth The fact that Asian countries are the greatest borrowers among emerging economies means that the issue of rising public debt is a particularly critical issue in these countries This is because Asian countries are located in the region with the most rapidly developing economies Asian economies also had two major crises during the time analyzed: the Asian financial crisis of 1998 and the global financial crisis of 2008, which boosted the public debt-to-GDP ratio in these countries

Unlike other studies in the world, the relationship between public debt and economic growth is mainly carried out in developed countries or countries with a clearly recognized market economy Domestic studies mainly find thresholds or just stop analyzing the situation between public debt and economic growth However, the thesis selected Vietnam as the research sample, with the economic operating mechanism under the management of the state having many differences compared to other countries On the other hand, from theory and empirical studies, it is shown that overusing and maintaining a high level of public debt will have negative effects on the economic growth of countries Therefore, the thesis does not search for thresholds but estimates the level of asymmetric impacts, including the specific positive and negative impacts of public debt on economic growth This topic's primary purpose is to evaluate the asymmetric influence of public debt on economic growth in Vietnam based on the preceding practice and previous empirical research The study examines whether debt is a barrier to economic growth in Vietnam and how government loans affect the short- and long-term sustainability of the economy The findings of this study will provide empirical evidence regarding the impact of public debt on the sustainable growth of the Vietnamese economy

1.2 RESEARCH OBJECTIVES

The purpose of this study is to examine the causal relationship between fiscal policies and economic cycles, serving as the basis for quantifying the asymmetric impact of Vietnam's governmental debt on economic growth The conclusions about the asymmetric impact of public debt on economic growth serve as the foundation for recommending fiscal policies for Vietnam

To accomplish the objective, the research must address the following specific aims:

(1) Assessing the impact of fiscal policy determinants on economic growth in Vietnam

(2) Determine the impact of fiscal policy on Vietnam's economic expansion (3) Examining the asymmetric impact of public debt on economic growth in Vietnam

(4) Analysing the effects and repercussions of the policy of public debt on the expansion of the Vietnamese economy

To achieve the goals of this thesis, it is necessary to respond to the following questions:

(1) Does Vietnam's fiscal policy have a causal relationship with economic growth?

(2) What is the extent of fiscal policy's influence on economic expansion? (3) Does public debt have an asymmetric impact on economic growth in Vietnam?

(4) How does an increase in public debt to a certain level have a negative impact on Vietnam's economic growth?

1.3 OBJECTS, SCOPE AND METHODOLOGY OF THE RESEARCH

The research topics include the areas of economic growth and public debt The study focuses on analyzing the correlation between fiscal policy indicators (total tax income, public debt, and government spending) and the business cycle indicator (economic growth) in Vietnam Specifically, it examines the relationship between public debt and economic growth in Vietnam from the first quarter of 2000 to the first quarter of 2021 The research data consists of quarterly data spanning from Q1 2000 to Q1 2021, which has been sourced from the IMF financial statistics (IFS) The variables of Vietnam's gross domestic product (GDP), growth in the money supply (BM), lending rate (IRO), public debt, USD/VND exchange rate, and

government expenditure do not follow a normal distribution Therefore, the departure from the average value is expected to be significant Hence, it is necessary to translate those variables into their natural logarithmic form and compute them concurrently by dividing the exchange rate of the current year by the exchange rate of the base year (which corresponds to the first quarter of 2000)

The research methodologies used in this study are quantitative, specifically employing the VECM model to examine and evaluate the correlation between fiscal policy and the economic cycle of Vietnam The study used an asymmetric regression model, known as NARDL, to analyze the unequal impact of public debt on the economic development of Vietnam Based on this assumption, the thesis presents recommendations for formulating policies related to Vietnam's national debt

This thesis uses the VECM (Vector Error Correction Model) framework to assess the relationship between fiscal policy and the economic cycle The VECM model does not have the capability to distinguish between endogenous and exogenous components, making it suitable for analyzing the causal relationship between fiscal policy and the economic cycle over both the short and long term In order to use the Vector Error Correction Model (VECM), it is essential that the data series have the same degree of integration after differencing and show cointegration The NARDL (Nonlinear Autoregressive Distributed Lag) model is used in the thesis to look at how public debt and fiscal policy affect economic growth in different ways, especially during Vietnam's economic cycle This approach relies on the established correlation between fiscal policy and the economic cycle The main need for using the NARDL model is that the data series must demonstrate integration at the highest degree of differencing, especially of order 1

1.4 THE SIGNIFICANE AND CONTRIBUTIONS OF THE RESEARCH

On the basis of theory and empirical studies on the influence of public debt on economic growth, as well as the current research gap, this study makes the following contributions and presents new points:

The relevance and theoretical contribution to science of the research

(1) The paper contributes to the application of theoretical foundations on public debt and economic growth to the experience of Vietnam, a country whose economy is transitioning to the market mechanism and contains numerous problematic components Theoretical underpinnings are then applied to the research sample, which is either the group of industrialized countries or the group of developing countries The selection of Vietnam as a research sample will contribute to elucidating issues of scientific theory when applied to economies with distinct characteristics, such as Vietnam, and whether or not the results are consistent with the theory and earlier empirical studies

Contribution to empirical research and practical importance

(2) Domestic research relies primarily on qualitative analysis, while international studies utilize the linear or threshold approach This article incorporates a model of the asymmetric impact of public debt on economic growth in Vietnam Second, the author rewrites the study under more volatile and integrated real-world conditions, where capital flows are highly liberalized, currency rates are more volatile, and global economies are dynamic The economies of the countries have experienced numerous fluctuations in recent years

(3) This study contributes in two ways to the empirical evidence now accessible First, only a handful of empirical studies have examined the public debt-to-GDP ratio threshold and its impact on economic growth in developing and transitional nations like Vietnam Second, the theory has demonstrated that Vietnam's public debt has an asymmetric effect on economic growth

1.5 RESEARCH CONTENTS

This research consists of five chapters:

Chapter 1: Introduction to the Research In this part, the topic will provide

an overview of the contents of the research topic, including the necessity of the

research, research objectives, research questions, research object and scope, research methods, and significance of the topic

Chapter 2: Theories and Literature Review The relationship between fiscal

policy and the economic cycle is discussed in Chapter 2 The topic will provide a summary of the theories and experiments underlying the connection between public debt and economic growth Regarding the theoretical literature, four schools of thought (Classical, Keynesian, Ricardian, and Modern Monetization) have presented varying explanations regarding the causal relationship between public debt and economic growth

Chapter 3: Research Methodology The topic describes the research model,

model variables, data used, and data processing procedures In the following chapter, the study uses the VECM model to test the relationship between fiscal policy and the economic cycle of Vietnam and the NARDL model to test the asymmetric impact of public debt on Vietnam's economic growth

Chapter 4: Research Results and Discussion On that basis, the study uses

the VECM model to test Vietnam's pro-cyclical fiscal policy A dynamic regression model with asymmetrical distribution lag (NARDL) is being used to investigate whether public debt has an asymmetrically negative influence on Vietnam's economic growth

Chapter 5: Conclusions and Policy Implications Chapter 5 summarizes the

results of Chapter 4 to answer the research questions In addition, the study also points out some policy implications for fiscal policy and economic growth in Vietnam

CHAPTER 2: THEORIES AND LITERATURE REVIEW

2.1 THEORIES OF FISCAL POLICY AND BUSINESS CYCLE 2.1.1 Concepts relevant to the research problems

2.1.1.1 The concept of fiscal policy

Fiscal policy is a subset of macroeconomic policy that influences economic activity through alterations in government expenditure and/or taxation Fiscal policy is disaggregated into government expenditure and revenue components to measure their effect on real GDP growth Government spending and/or tax adjustments are examples of fiscal policy's macroeconomic effects on economic activity Mobilizing financial resources to meet the state's spending needs; promoting economic restructuring; ensuring stable and sustainable economic growth; contributing to market and commodity price stabilization; and redistributing social income between classes of the population are the objectives of fiscal policy (Furceri and Jalles, 2016)

The government intervenes in the economy via fiscal policy (government spending, taxes, subsidies, etc.) and monetary policy (money supply, interest rates, exchange rates, etc.) during periods of economic recession or rapid growth According to the recession or economic growth cycle, fiscal and monetary policy are split into procyclical and countercyclical stages Pro-cyclical fiscal policy is a fiscal policy that seeks to balance the budget To balance the budget when there is a deficit, it is important to increase tax collection and reduce government spending A countercyclical fiscal policy is one with the objective of restoring output to its potential level In order to achieve potential output levels during a recession, the government continues to raise government spending and decrease tax receipts (Keynes, 1936)

In developed nations, governments frequently employ a countercyclical fiscal strategy, i.e., an expansionary fiscal policy while the economy is in recession and a contractionary fiscal policy when the economy is in expansion The fiscal policies of developed nations are countercyclical because of automated stabilizing

instruments When unemployment is high, unemployment insurance and social transfer payments are increased As declining personal income reduces government tax collection, tax policy can potentially reverse the cycle While the economy exhibits signals of contraction, expansionary fiscal policy is enacted (Acemoglu et al., 2013; Fatas and Mihov, 2013)

While the primary objective of macroeconomic policy in developed countries is to stabilize the economic cycle, countercyclical fiscal policy is implemented to accumulate during the expansion phase In contrast, developing country macroeconomic policy is pro-cyclical The fundamental reason is that, in order to catch up with developed countries, emerging economies frequently increase investment and public spending, particularly when the economy is recovering When the economy is expanding, the government, particularly the local government, desires to increase spending During economic downturns, developing nations frequently lack automated stabilization instruments Unemployment insurance payouts are infrequent, and social transfers represent a negligible portion of the budget The majority of spending in developing nations is allocated to government consumption and wages In emerging nations, indirect taxes (trade and consumption taxes) frequently replace direct taxes (income taxes) In order to achieve its long-term macroeconomic management objectives, the government must employ fiscal policy effectively and at the appropriate moment during a recession or rapid economic expansion Vegh and Talvi, 2005)

2.1.1.2 The concept of the Business Cycle

The business cycle explains the expansion and contraction of an economy The economic cycle is the economy's response to real shocks, such as technological advancements, natural disasters, and conflict Negative or positive economic fluctuations can spread and generate cycle fluctuations (Kydland & Edward, 1982)

In the past two decades, the majority of nations have experienced economic cyclicality as a result of the 1997 and 2008 financial crises In reality, economic cycles are unpredictable and erratic There is no formula or approach for predicting the time and duration of business cycles with precision Governments continue to explore whether fiscal and monetary policy measures will be deployed to regulate

the economy more steadily, and research into the economic cycle is conducted in an effort to limit economic crises and overheating

The economic cycle is the result of market fluctuations, which cause the economy to experience recessionary peaks and troughs The response of fiscal and monetary policy to economic shocks has a significant impact on the subsequent evolution of the economy (Keynes, 1936)

2.1.2 Theories of Fiscal Policy and Business Cycle

According to Keynesian theory, prices or wages represent instantaneous price adjustments that are not fully responsive to fluctuations in demand the With the support of countercyclical fiscal policy, the economy can recover from recessions and expansions more swiftly and smoothly Consequently, fiscal policy should actively smooth and support the business cycle by decreasing taxes and increasing spending, thereby increasing aggregate demand in the downward stage, and by reducing spending and increasing savings in the upward stage Although this is perhaps less relevant for developing countries, where social safety is less developed (Thornton, 2008),

From a neoclassical perspective, the objective of fiscal policy should be to minimize deviations Barro's (1979) hypothesis states that in order to assure that spending shocks or tax shocks are transitory, tax rates must be maintained at constant levels throughout the business cycle Therefore, the budget balance should have a positive correlation with output, given that it absorbs changes to tax revenues induced by tax shocks as well as changes to other incomes and expenditures (Fatás and Mihov, 2009; Chari et al., 1994)

Keynes (1936) claimed that relying entirely on the private sector would not generate sufficient savings for economic growth in developing countries Therefore, Keynesian economists have been urging low-income developing countries (LDCs) for a considerable amount of time to raise their tax burdens and reduce their recurrent spending in order to boost their savings in the government budget In addition, they encourage the governments of developing nations to enhance their public investments funded by foreign loans These policies were prevalent in the

1960s, 1970s, and 1980s in developing countries However, there are several issues with these policy suggestions For example, they don't go into enough detail about how macroeconomic variables relate to each other, and they don't pay enough attention to basic aspects of fiscal policy like long-term stability, fair distribution, and the efficient use of resources Instead, they focus too much on short-term growth goals The Keynesian theory disregards the fact that the government cannot inject purchasing power into the economy prior to diminishing it via taxes and debt The Keynesian hypothesis was questioned when the global economy entered a recession in the 1970s and when tax cuts and austerity spending led to an economic boom in the 1980s

Keynes theorized that the government should intervene in the economy by raising taxes and expanding government expenditure to deal with the economic crisis and the high unemployment rate, as well as influencing the business cycle Government spending is a public investment that injects additional funds into the flow of income, hence increasing aggregate demand These expenditures are funded by the economy's tax revenue, thus invisibly reducing consumption and reducing corporate profits Additionally, the government obtains income via the sale of government bonds and other forms of borrowing Consequently, it is probable that the budget deficit and the state's debt burden will increase and that the state's economy will continue to deteriorate due to other secondary negative impacts that hamper business conditions and productivity The following situations may occur: To promote demand, taxes must be lowered, but tax cuts produce budget deficits and reduce government spending If government spending rises, the marginal efficiency of capital is likely to decline It also creates inflation and increases the budget's debt burden (Dinh Van Thong, 2009)

Contrary to the Keynesian perspective, many economists believed for decades that reducing the budget deficit was the "magic elixir" for economic expansion They contend that reducing government expenditure will reduce the budget deficit, thereby lowering interest rates, increasing investment, boosting productivity, and ultimately promoting economic growth If the relationship between the aforementioned factors is close, this argument is valid, and fiscal policy

should focus on addressing the deficit problem There are, however, reasons to believe that the relationship between budget deficit, interest rate, investment, and growth is exaggerated However, neither school stresses the magnitude of budget expenditures Keynesian economists are normally concerned with large quantities of government expenditure, but they are also unconcerned with small amounts of government spending, so long as they can be increased as necessary to rescue the stagnant economy Today, the majority of economists concur that there are situations in which government spending cuts are advantageous to economic growth, as well as situations in which government expenditure increases are favorable to economic growth In the 1930s and 1960s, ideas of market failure led to the establishment of enormous government spending programs under the framework of fiscal policy However, in the 1970s and 1980s, the downsides of government spending programs began to show, compelling economists and political scientists to research government failures Therefore, the market frequently fails, and the government rarely succeeds in overcoming market failures Among the primary reasons for government failure are: slow policy issuance and implementation results from limited information, limited control over the private sector, bureaucracy, and constraints of the political consultation process (Le Mai Trang, 2018)

The most ideal form, according to current contemporary economic theory, is a mixed economy with a balanced role for the government and the market (Mankiw, 2005) The government manages the market using tax, expenditure, and regulatory programs within a market economy model that decides prices and output Markets and government are both decisive variables Managing the economy without government and the market is like "clapping with one hand." The market economy increases the efficiency of production and distribution of products, but it also has drawbacks that necessitate government intervention to assure efficiency, fairness, and stability The endogenous growth model has become an essential theoretical foundation for contemporary fiscal policy (Barro, 1979) This theory posits that fiscal policy has both short-term and long-term effects on economic growth and social problems, similar to Keynesian theory In practice, it is difficult to distinguish

between fiscal policy's short-term and long-term consequences, as well as whether the effects are more permanent By adopting this framework, the government can make informed and nuanced economic adjustments through the use of fiscal policy The "visible hand" of the state and the "invisible hand" of the market are harmoniously combined in fiscal policy, which is based on Keynesian philosophy but is more logically finished How much tax revenue the state should collect to guarantee equity and maximize incentives, how much of that revenue should be used to address market flaws, and how much should be used to highlight the sector's strengths—these are all questions that need answers A more dynamic and adaptable perspective of the budget's revenue and expense balance is revealed (Dinh Van Thong, 2009)

2.2 THEORETICAL OF PUBLIC DEBT AND ECONOMIC GROWTH 2.2.1 Theories of Public debt

Taxes, duties, fees, revenue, property and business revenues, taxes, and fines are just a few examples of the public revenue sources that frequently support public spending However, the state faces a public budget deficit due to causes such as large infrastructure investments, war, financial development, natural disasters, the economic crisis, the budget deficit, and ordinary public spending To overcome this situation, public sector borrowing is mentioned

Public debt refers to the legal obligation of the state to return principal and interest to the holders of predetermined rights according to a certain schedule Debts owed by the government or other public institutions are public credit and public debt, also known as state debt Borrowing is possible in some cases, such as large infrastructure investments and wars, but it emphasizes that borrowing should be limited and should not be continued After the Second World War, public debt increased significantly and changed structure due to the restoration of the economies and physical facilities of the countries affected by the war The other is the financial needs of developing countries In the later stage, the borrowing process is no longer transnational but begins to take on a new dimension with the

establishment of international organizations such as the International Monetary Fund (IMF) and the World Bank (WB) (Ulusoy et al., 2013)

According to the 2015 World Bank Report, the term "public debt" encompasses the entirety of the government's explicit, time-bound contractual obligations that remain unfulfilled beyond a designated deadline The composition of liabilities encompasses both domestic and international components, including loans, cash holdings, and securities tied to currencies

In the process of globalization, capital mobility is increasing, and increasingly fierce financial competition has appeared in the global market In particular, developing countries have sought to use public debt to finance development by attracting international short-term capital flows to their countries through various incentive instruments (such as low taxes, low interest rates, etc.) However, both the sudden fluctuations in capital flows and the incentive mechanisms deployed have dragged developing countries into a spiral of external debt Borrowing can be spent irresponsibly because it is an easy income, thereby causing a downturn in the performance of the economy Capital is wasted, and the debt burden is passed on to future generations due to inefficient public spending (Sugözü, 2010)

2.2.2 Classical theories of public debt and economic growth

The founder of classical economics, Ricardo (1817), stated that public debt tends to cause countries to be unclear about their actual condition, which in turn leads to irrational public spending This concept holds that paper wealth stimulates consumer demand, tightens investment, and slows capital and consumer goods expansion Classical economic theorists claim that debt-financed governmental spending does not entirely offset the negative consequences of crowding out private investment, resulting in a slowdown of the economy Thus, government borrowing from the domestic market induces a liquidity crisis and a spike in interest rates, which discourages private investment

Ricardo contends that, regardless of debt equity financing or tax hikes, the overall economic level has a lasting effect on demand According to the hypothesis, if taxes were to be raised, debt could be repaid, and people's income would rise as a result of their purchase of government-issued bonds Ricardo explains further that when the government lowers taxes and decides to finance its budget deficit through the issuance of bonds, households are often sensitive to increased consumption because they believe the government will raise taxes in the future to repay the debt; as a result, the debt has a long-lasting effect on economic growth Public debt hinders economic growth, according to the classical school of thought, because it decreases both the fiscal discipline of the budgeting process and the private sector's access to credit (Broner et al., 2014) In addition, they argue that the repayment of public debt, which is often foreign debt, hinders economic growth by discouraging private investment and potential foreign investors

Changes in government expenditure and the resulting increase in public debt are mirrored by changes in private saving; therefore, they have no impact on actual economic growth As Ricardo (1817–1951) noted, the real economy is not dependent on the government's option to increase revenue, such as through taxation or debt issuance, in certain circumstances "The Financing System" and "On the Principles of Political Economy and Taxation" were Ricardo's 1820 and 1877 works on public debt's effects on resource allocation and economic growth, respectively In the 20th century, Barro (1974) and Buchanan (1976) popularized Ricardo's position in their articles titled "Are government bonds a net asset?" and "Is public debt comparable to taxes?" Barro and Buchanan's theoretical and empirical contributions led to what is now known as the Barro-Ricardo Equivalence Hypothesis, or REH (Ricardian) According to the research of Barro (1989) and Buchanan (1976), public debt has no negative economic effects as long as solvency is not an issue In other words, REH asserts that public debt explains financial mobility exclusively among economic players (Barro, 1989) Buchanan (1976) believes that governmental debt has only a direct effect on private spending and saving decisions and has no effect on the likelihood of net economic growth This

implies that changes in domestic and foreign public debt are independent of changes in major real macroeconomic variables, such as total investment and production, and hence do not effect economic growth (Barro, 1989) In the neoclassical perspective, expansionary fiscal policies do not alter economic performance (Barro, 1976; Pereira & Rodrigues, 2001) Thus, the Barro-Ricardo Equivalence Theory contends that public debt cannot be employed as an economic stimulant (Barro, 1989)

Six assumptions form the theoretical foundation of Ricardo's work The first is a perfect capital market—a credit climate that permits market participants to borrow freely The second assumption is that the growth rate of the population, in this case, taxpayers, remains constant Third, both economic agents and consumption decisions are rational The fourth hypothesis is transfer between generations The fifth assumption holds that the future tax burden on public debt will provide all services to those who benefited from the first tax cut The sixth hypothesis concludes that there are no outstanding taxes (Barro, 1974, 1989; Buchanan, 1987) Therefore, according to Barro's (1974, 1989) arguments, a change in the government's funding strategy will necessitate an equal adjustment in private saving to counteract changes in public saving (Elmendorf & Mankiw, 1999)

According to the Keynesian perspective, public debt grows when circumstances require the government to incur substantial deficit spending According to Keynesianism, having too much public debt is not a problem because the higher interest income that the public receives from holding public debt covers the cost of having too much debt Keynes opposed any effort aimed at decreasing or merely halting the growth of debt According to Keynes' theory, public debt encourages job growth, which lowers unemployment and boosts participation Public expenditures supported by debt have an additive effect, resulting in a multiplier effect that is beneficial for national output or income

Keynesian economic theories assert that governmental debt limits the availability of capital from private investors but has no effect on consumption

because borrowed funds are reinvested to enhance overall demand through wages and other capital expenditures As a result, Keynesian economic theorists disregarded the difficulty of covering budget deficits through an increase in tax revenues or government borrowing In practice, however, taxpayers feel the tax burden when the government boosts tax rates to collect income to offset the growing debt Additionally, in order to reduce their tax burden, taxpayers will find ways to reduce their employment and savings This causes the government to hike tax rates further, and so on, until the taxpayer discovers a way to avoid paying taxes The decline in the ratio between after-tax wages and profits reduces national income and savings In addition, an increase in interest income in the majority of nations will push the taxable personal income of many households into a higher tax band, particularly in nations with significantly raised tax rates Another flaw of this perspective is that it grossly underestimates the economic advantages obtained or lost as a result of the issuance of public debt

Excessive debt refers to a scenario in which the debt is asymmetrically greater than the revenues created by new investment projects to service existing debts Therefore, profitability cannot decrease the amount of debt or improve the firm's worth (Myers, 1977) When sovereign governments gain from their debt, Krugman (1988, 1989) and Sachs (1989) argue that a high level of debt suggests an increase in predicted future tax rates Therefore, the over-indebtedness theory asserts that a country's debt will exceed its ability to pay It is anticipated that debt costs will hinder foreign and domestic investments In fact, the predicted rate of return on effective investment projects is insufficient to stimulate economic growth (Krugman, 1988) In addition, Claessens (1990) and Clements et al (2003) argue that outstanding loans represent a circumstance in which the illiquidity impact, the discouraging effect, or both are substantial enough to hinder economic growth Additionally, due to the uncertainty of private investors, the accumulation of debt hampers economic growth Because an increase in the money supply results in an increase in public debt and a reduction in future tax revenues, governments must address immediate needs

2.2.3 Neoclassical theories of public debt and economic growth

Since the 1960s, neoclassical economists have observed that higher taxes to cover interest payments on the nation's expanding domestic and international debt have had a detrimental impact on capital development High and rising public debt has a negative impact on economic growth through a number of channels, including: (1) the dominance of private investment as government borrowing competes for capital on the country's capital markets; (2) higher long-term interest rates due to the supply of public debt and larger credit risk premiums; (3) the imposition of more distortionary taxes to finance future liabilities and increased repayments; and (4) an increase in the inflation rate

The short-term link between debt and growth may be favorable due to the impact of investment spending on growth; however, the long-term relationship may be negative due to the high risk premium associated with high public debt, hence increasing the cost of debt The negative correlation between debt and growth as a result of countercyclical fiscal policy implies that governments in recession should undertake expansionary fiscal policies to stimulate growth and restrictive policies to lower debt levels in the interim

In the postwar era, the impacts of redistribution from one generation to the next have been the subject of significant discussion The public debt is no longer a burden on taxpayers This burden is instead shifted, in whole or in part, to future generations, who must pay taxes to settle the debt In a similar spirit, proponents of Ricardian neutrality argue that the existence of an active intergenerational debt burden is crucial to the possibility of debt neutrality As a result, a discussion arose regarding the modeling of the effects of fiscal policy, particularly debt swaps, as well as their impact on social utility and interest rates

In recent years, neo-Keynesian economists have argued that debt levels are of little consequence as long as interest rates on public debt remain below long-term growth rates This perspective on the relationship between debt growth and deficit

drivers may overlook current primary deficit drivers and the increasing impact of the rising debt ratio (public debt to GDP) on long-term interest rates Recent studies imply that a significant increase in the debt-to-GDP ratio can result in significantly higher taxes, reduced future incomes, and a debt burden for future generations

In addition to these theoretical justifications, the threshold theory or the nonlinear effect also supports the existence of a nonlinear relationship between the level of public debt and economic growth According to this hypothesis, an increase in public debt levels has good benefits for economic growth when debt levels are low but negative consequences when debt levels are above a particular threshold (Reinhart and Rogoff, 2010)

Figure 2.1 The relationship between public debt and economic growth

Source: Barro (1974)

Figure 2.1 demonstrates that at low debt levels, an increase in the debt ratio stimulates the economy in accordance with the standard Keynesian multiplier The additional debt level as a percentage of GDP will have a detrimental effect on economic growth once the debt ratio reaches a high level (nonlinear threshold) The existence of a nonlinear threshold suggests that neoclassical views of the relationship between debt and growth may have some validity According to these

Public debt/GDP ratio Nonlinear threshold

beliefs, the impact of future tax rises on debt sustainability is anticipated to lower economic activity (Barro 1974) Alternately, a nonlinear threshold may imply that rising government borrowing may boost competition for funds on the nation's capital markets, resulting in higher interest rates

Smith argued that even if domestic investors hold all of the debt, governments shouldn't run deficits because debt accumulation is "hazardous" for the country In actuality, Smith rejects the mercantilist concept that paying interest on public debt is analogous to "the right paying the left." This is due to the fact that the necessity to buy back debt early will result in tax rises, a decline in local capital, and currency devaluation, all of which have a detrimental effect on the remaining domestic producers (Smith, 1937) According to Smith, the public debt burden impedes a nation's "natural development toward riches and prosperity" by diverting private sector resources to pay for inefficient government activities Smith consequently advocated for a balanced budget that relies entirely on taxes to pay for all government expenses Deficits in the budget are only acceptable in dire circumstances, such as war or natural disasters Smith contends that the method of financing public expenditures (i.e., through taxation or the issuance of bonds) is vital to capital accumulation in such situations However, taxes mostly lower household expenditures and produce modest savings As a result, the money the government raises through borrowing or taxing will stifle private investment to the same extent As a result, taxation inhibits future investment and capital accumulation, hence diminishing the productive potential already in place

Financing government spending with debt is detrimental to the economy and its ability to generate prosperity The concept is that borrowing directly affects savings, or income that can be invested successfully Because government expenditures are often inefficient (e.g., paying employees, supporting the military, fighting wars, etc.), public debt decreases the economy's capacity to accumulate wealth When these expenditures are necessary, taxes are the preferred method of supporting them Smith was the first to propose that taxes are mostly paid with

current earned income and that this only affects private consumption without harming the economy's capacity to accumulate

Hansen (1968) emphasizes the use of debt financing when a budget deficit is incurred during times of war or natural disaster Hansen proved that higher lending during wartime supported economic expansion and the formation of credit institutions Hansen equated unemployment with a state of emergency; hence, the government may use debt to reduce or eliminate unemployment

2.2.4 Modern monetary policy on the relationship between public debt and economic growth

At the current stage of macroeconomic study, it is widely held that large public debt exerts a major downward force on capital and wage rates, resulting in slower economic growth High governmental debt and deficit expenditures will not stimulate consumption or investment

The idea underpinning why government borrowing might be detrimental to economic growth focuses mostly on budget deficits According to this idea, an increase in the federal budget deficit results in an increase in the government's demand for capital from the private sector, as it seeks to borrow money from both domestic and overseas investors This means that, in a healthy economy, the government will begin to compete with private borrowers for a fixed source of savings, resulting in an increase in interest rates This rate increase could discourage and impede private sector investments in machinery and equipment This drop in investment reduces the total quantity of operating capital available to the economy, which in turn reduces the rate of future growth On the other side, rising debt levels might cause investors to be concerned that a country would not be able to pay its creditors As a result, investors exiting the country's debt might cause an increase in interest rates, as creditors must be assured of better returns to continue financing the nation's deficits A sudden increase in interest rates will "disturb" the financial sector and impact growth through this channel at that moment During the period of

excessive debt, financial crises induced by excessive debt have imposed substantial economic consequences on a number of nations (Reinhart and Rogoff, 2010)

Numerous studies demonstrate that various variables can affect the transmission mechanism between high levels of governmental debt and economic activity Kumar & Woo (2010) find that the negative impact of high persistent debt levels in the public sector on economic growth is mostly attributable to the deceleration of labor productivity growth as a result of a decline in investment and a decline in stock capital accumulation (Cecchetti et al., 2011) show that in the future, rising debt levels may hinder the availability of credit flows, hence having a negative impact on growth via transmission channels High amounts of public debt can increase the risk premium, resulting in higher financing costs, which might threaten the sustainability of public finances (Kirchner et al., 2010) According to Perotti (1999), early fiscal conditions characterized by deficits and public debt are crucial drivers of the deployment of fiscal reforms Cecchetti et al (2010) believe that as investors lose faith in the government's ability to repay debt, the risk premium for issuing government bonds rises, which can lead to an unstable debt situation and a recession There are four primary avenues through which alterations in the public debt affect economic growth These consist of (a) private saving, (b) public spending and investment, (c) overall productivity, and (d) sovereign long-term real and nominal interest rates (Buffie et al., 2012)

Theories categorize the relationship between public debt and economic growth into four groups: no effect, negative effect, positive effect, and nonlinear effect

2.2.5 Theories of the linear impact of public debt on economic growth

This theory assumes that the impact of public debt on real macroeconomic indicators is negative The debt balance hypothesis explains fundamentally the negative impact of public debt on economic growth Myers (1977) suggested that the accumulation of public debt during a fiscal slump affects the private sector's

ability to make optimal future investment decisions (Reinhart et al., 2012) Several traditional growth models, primarily in neoclassical and endogenous contexts, support this notion, stating that public borrowing lowers fiscal discipline and increases future tax burdens (Buchanan, 1958; Diamond, 1965; Meade, 1958; Modigliani, 1961) According to Diamond's (1965) reasoning, the amount and variations in taxes resulting from domestic and foreign public debt have a detrimental impact on the development of total equity

According to the debt balance hypothesis, public debt negatively affects economic growth through three pathways (Cecchetti et al., 2011; Cochrane, 2011b; Patinkin, 1965; Panizza & Presbitero, 2013; Perotti, 2012; Soydan & Bedir, 2015) The first is the rational expectations theory, which posits that the large influence of public debt on economic growth is the result of erroneous macroeconomic forecasts (Churchman, 2001) According to rational expectations theory, the negative consequences of public debt can be amplified if high public debt creates uncertainty about future policy outcomes or leads to higher tax revenues in the future, possibly through inflation and financial repression (Cochrane, 2011a; Panizza & Presbitero, 2013) The second mechanism via which public debt negatively impacts economic growth is the crowding-out effect The crowding effect occurs when public spending displaces private spending by nearly the same amount This occurs when government borrowing incurred as a result of a fiscal slump lowers the economy's ability to lend, resulting in a considerable rise in real interest rates that discourages private sector investment, thereby causing an economic slowdown (Huang et al., 2018) Moreover, if market actors restrict access to loans, public debt can undermine the economy (Broner et al., 2014) As a result, either a price (interest rate) or a quantity (credit allocation) can offset the effect of public debt on private investment In addition, repression theory says that public debt paid for by unfair taxes or new debt makes inefficient public policy even worse, which affects the choices of private businesses and leads to divestment (Soydan & Bedir, 2015) According to Soydan and Bedir (2015), in an unstable economic environment, the majority of investments will be short-term and have quick paybacks, resulting in

diminished long-term economic growth Additionally, the structure of the investment, savings, and liquidity markets determines the impact of public debt on economic growth

Wagner's notion of the "law of growing state activity" and the Keynesian fiscal multiplier effect provide support for the significance of public debt in a country's economic growth On the other hand, Wagner (1893) theorized that there is a positive correlation between the level of economic growth and the relative size of the public sector, which leads to an increase in public spending, primarily on debt Thus, in a restructuring state, government activities and functions expand to suit the economic, social, political, and cultural requirements of the populace (Bird, 1971) According to Wagner (1911), the progress of industrialization and urbanization necessitates the creation of infrastructure that is both complex and costly In other words, as society develops towards modernity and urbanization, the government provides more and more commodities and services Lybeck (1988) adds that education, health, and other social services and goods form a demand function that is income-elastic and that increasingly sophisticated military technology will absorb a greater proportion of national wealth According to these theoretical frameworks, government securities (public debt) function as liquid assets, and their increase affects economic growth and liquidity provision (Kobayashi, 2015)

On the other hand, Keynes's view of the positive relationship between public debt and economic growth has two sides: (a) rising public debt causes high levels of efficient public spending, which then act as automatic stabilizers in the economy; and (b) deficit-funded government spending has a greater positive effect on the multiplier than tax-funded government spending (Holtfrerich, 2013) Keynes's reasoning indicates that an increase in public sector spending (public debt) might promote domestic economic activity and entice private investment, hence raising the net rate of return (Elmendorf & Mankiw, 1999)

In addition to Keynes's view, there is another theory that explains the positive relationship between public debt and economic growth This theory is based on the premise that government borrowing from financial funds and interstate capital is required to fill the gap between domestic investment and saving (Pattilo et al., 2002) Elmendorf and Mankiw (1999) suggest that short-term foreign debt will stimulate aggregate demand and promote an increase in national output by introducing fresh financial resources into the economy

Delong and Summers (2012) also claim that the effect of public debt on economic growth is beneficial In an economy where output is below potential, high external debt will have a positive influence on the fiscal multiplier In other words, fiscal expansion is self-financing and promotes aggregate demand in a weak economy when interest rates rise, resulting in economic growth, according to Greiner (2006)

In addition to the favorable effects of international public debt on the economy, domestic public debt also has positive consequences for the economy Specifically, Gulde et al (2006) contend that government borrowing from the local debt market serves to strengthen the domestic currency and financial markets, as well as encourage private saving and, consequently, overall investment (Abbas & Christensen, 2007) According to Abbas and Christensen (2007), monetary authorities would have little control over loan ceilings, interest rates, and high reserve requirements in economies with well-developed domestic debt markets Financial regulations skew lending decisions in the banking sector, resulting in financial intermediation at the price of savings and investment in the private sector

Moss et al (2006) and Christensen (2004) describe the positive effect of domestic public debt on economic growth; government availability and access to domestic funding can also help to counterbalance the effects of external shocks on the economy, which weaken domestic financial institutions Moreover, Christensen (2004) adds that the availability and accessibility of domestic public debt