SUMMARY OF THESIS The thesis explores the relationship between fiscal policy, public debt, and economic growth in the context of Vietnam.. The primary aim of the study is to assess the i
INTRODUCTION OF THE RESEARCH
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)
Macroeconomic policies differ between developed and developing nations Developed nations use countercyclical fiscal policy to accumulate during economic expansion for stabilization Conversely, developing nations implement procyclical policies, increasing investment and spending during economic recovery Governments in these countries prioritize spending during economic expansion due to limited automatic stabilization mechanisms Fiscal policy is crucial in developing nations for achieving macroeconomic objectives, as it includes a substantial portion of government consumption and wages, often with a reliance on indirect taxes.
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
Government fiscal policy, particularly through debt, taxation, and expenditure, has a substantial impact on economic growth While public debt can play a role in economic development, its effects can vary across economies Empirical and theoretical inconsistencies have led to disparate policy approaches regarding the relationship between public debt and economic growth Notably, beyond a certain threshold, public debt can have detrimental consequences for economic growth, necessitating accurate quantification of its negative effects.
The relationship between public debt and economic growth remains a complex and controversial topic While some studies suggest a positive correlation, others observe a negative one, and still others find no significant relationship at all However, 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.
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?
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)
This study utilizes quantitative research methodologies, employing the VECM model to analyze the relationship between fiscal policy and Vietnam's economic cycle The asymmetric NARDL regression model is employed to assess the varying impact of public debt on economic growth The study provides policy recommendations for managing Vietnam's national debt based on the premise that public debt has a differential effect on economic development.
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.
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.
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.
THEORIES AND LITERATURE REVIEW
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)
Government intervention in the economy is achieved through fiscal (government spending, taxes, subsidies) and monetary (money supply, interest rates, exchange rates) policies during economic downturns or growth spurts These policies can be procyclical, aiming for budget balance by increasing taxes and reducing spending in deficit periods, or countercyclical, aiming to restore output to potential levels by increasing government spending and reducing tax receipts during recessions.
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
Economic cycles are driven by market fluctuations, leading to alternating periods of economic expansion and contraction Government interventions through fiscal and monetary policies significantly influence the economy's trajectory in response to these shocks, as theorized by Keynes in 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).
THEORETICAL OF PUBLIC DEBT AND ECONOMIC GROWTH
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, a legal obligation to repay borrowed funds, involves governments seeking loans for infrastructure or conflict Post-World War II, public debt surged as war-torn nations rebuilt Developing countries' financial needs further contributed to borrowing Notably, international organizations like the IMF and World Bank emerged, facilitating global lending and reshaping the nature of public debt.
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 (Sugửzỹ, 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
Alterations in government spending and corresponding increases in public debt are reflected in shifts in private savings, indicating a neutral impact on economic growth David Ricardo asserted that the actual economy is unaffected by government revenue-generating measures like taxation or debt issuance In his works "The Funding System" (1820) and "On the Principles of Political Economy and Taxation" (1877), Ricardo explored the effects of public debt on resource allocation and economic growth.
The Barro-Ricardo Equivalence Hypothesis (REH) emerged in the 20th century, popularized by Barro (1974, 1989) and Buchanan (1976) This theory asserts that public debt has no negative economic consequences when solvency is not an issue According to REH, public debt only influences private spending and saving decisions, without affecting economic growth or key macroeconomic variables This implies that expansionary fiscal policies, which increase government debt, do not stimulate economic performance.
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
High public debt negatively impacts economic growth by diverting private investment, raising interest rates, necessitating distortionary taxes, and escalating inflation Government borrowing competes for capital on capital markets, reducing private investment Increased public debt supply leads to higher long-term interest rates and credit risk premiums Financing future liabilities and increased repayments require higher taxes, which hinder economic activity Additionally, elevated public debt may contribute to inflation, further dampening growth prospects.
Debt's short-term impact on growth can be positive due to investment spending, but long-term effects can be adverse because high public debt leads to increased risk premiums and higher borrowing costs Countercyclical fiscal policy suggests that governments should implement expansionary measures during recessions to stimulate growth and adopt restrictive policies later to reduce debt levels.
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
RELEVANT EMPIRICAL STUDIES ON THE RELATIONSHIP BETWEEN
2.3.1 Literature review of procyclical fiscal policy
Gavin and Perotti (1997) concluded that fiscal policy in 13 Latin American countries from 1968 to 1995 was pro-cyclical The authors stated that the fiscal policy of developing nations is the polar opposite of that of developed countries The cyclical metric increases the government's budget surplus by 0.25 percent for every one percent of GDP growth during periods of economic expansion During a recession, both the deficit and the gross domestic product decrease by 1 percent As a result of procyclical fiscal policies during periods of sluggish economic growth, these nations suffered severe economic losses The study also explains why the pro- cyclical fiscal policy operations of these countries are associated with the "greedy effect," which causes political distortions when political interest groups make more spending decisions while the economy is booming Ilzetzki and Vegh (2008) studied the cyclical effects of fiscal policy on the business cycle, as well as the reverse causality between them, by using a variety of econometric models For the sample of developing countries selected by the two researchers, the GMM regression determines that fiscal policy has a pro-cyclical character Similarly, Lane (1998) has shown that Irish fiscal policy is pro-cyclical
Talvi and Végh (2005) conclude that the procyclicality of fiscal policy is prevalent in all 36 developing countries in their sample and not just in Latin America The study demonstrates a positive association between the composition of government expenditures and GDP for a sample of 36 emerging nations (with a mean coefficient of 0.53) Thornton (2008) discovered in an analysis of 37 African nations between 1960 and 2004 that the real government consumption in 32 of these nations is procyclical to output changes Manasse (2006), who generates cyclical estimates by means of nonlinear techniques, issues a warning Find the observed disparities in the economic cyclicality of fiscal policy between developing and developed nations, which are in part attributable to the greater severity of economic shocks in developing nations
Kaminsky and Végh (2004) analyzed the cyclicality of capital flows, fiscal policy, and monetary policy in 104 countries from 1960 to 2003 and reached the following conclusions: (1) Capital flows are a procyclical input in OECD and emerging nations; (2) Fiscal and monetary policy are procyclical for the majority of developing nations, with the effect being most prominent in upper middle-income nations For OECD countries, monetary policy is countercyclical; (3) in developing countries, the capital flow cycle and the macroeconomic cycle are mutually reinforcing, with the capital inflow period associated with expansionary macroeconomic policy and the capital outflow period associated with contractionary policy
Numerous empirical studies have established the procyclicality of fiscal policy in developing countries Studies by Stein et al (1999), Talvi and Vegh (2005), Kaminsky et al (2004), and Akitoby et al (2004) have consistently found positive correlations between public consumption and economic growth, indicating that fiscal policy tends to fluctuate with the business cycle in these countries.
The fiscal policy trend in developing nations and numerous emerging economies is pro-cyclical Studies have shown potential causes of procyclicality, including institutional weakness, social friction, and a loss in creditworthiness on international credit markets (Alesina and Tabellini, 2008) Research shows that corruption and democracy are the two most important factors that affect cyclicality in developing countries According to the GINI index, the coefficients for the relationship between net external debt and social inequality frequently oscillate around the 10% significance level Thus, institutional difficulties are the primary reason for cyclical fiscal policy (Halland and Bleaney, 2011)
Fiscal policy and the economic cycle have been extensively studied, especially regarding the differences between developed and developing countries Key theories propose that access to credit markets (Caballero and Khrisnamurthy, 2004; Gavin and Perotti, 1997; Calderón and Schmidt-Hebbel, 2008), political structures (Lane, 2003; Talvi and Végh, 2005; Alesina et al., 2008), and wealth inequality (Woo, 2009) heavily influence this relationship.
Alessia and Tabellini (2008) explored the association between corruption, political issues, and fiscal policy using data from OECD countries and a few non- member countries to construct models for 83 nations between 1960 and 2003 They concluded that democracies with higher levels of corruption result in more pro- cyclical fiscal policy implementation According to their assessment, if a government is corrupt and voters observe a substantial increase in the economy's income, they will quickly demand more public goods from the government and tax cuts, resulting in a procyclical skew in fiscal policy Voters' concerns about misusing national resources for political gain are what inspired this action Furthermore, the study demonstrates that procyclical fiscal policy is more prominent in economies with high levels of corruption In a circumstance in which voters perceive the state of the economy but are unable to verify the amount of government income collected by the state bureaucracy The majority of budget surpluses are expected to be spent on plundered funds by voters rather than going toward the nation's savings In order to "grab as much of the pie" as possible, voters urge increased expenditure (tax cuts, higher government spending, or transfers) in favorable times This public pressure compels the government to spend in accordance with the business cycle and to even borrow more money The empirical findings support the premise that countries with a greater prevalence of corruption have fiscal policies that are more pro-cyclical In addition, they uncover evidence that pro-cyclical fiscal policy is most prevalent in democracies and corruption, where high levels of corruption are associated with high levels of voter accountability They discover that the confluence of democracy and corruption is more likely to result in pro-cyclical fiscal policy; they ascribe this to democratic pressure on government expenditures to prevent them from being usurped by corruption
Some theories of the procyclical character of fiscal policy in developing countries contend that developing countries confront credit limits that prevent them from borrowing during economic downturns and that they were forced to service their obligations during that time, prompting a contractionary fiscal policy when economic growth weakened The credit constraint theory states that developing countries are less likely to smooth the business cycle due to their inability to borrow from international credit markets during economic downturns Gavin and Perotti initially suggested this explanation (1997) According to their research, fiscal cyclicality in Latin America is particularly severe during economic downturns In addition, they find that the IMF's fund accessibility to emergency finance is greater during these periods and that the initial fiscal deficit defines the procyclicality of fiscal policy They interpret the data as evidence that investors limit financing to nations where they fear that high fiscal deficits could become unmanageable Aghion et al (2014) examine the extent to which enterprises have recourse to external loans to finance company expenses This impacts the economy's ability to recover from a recession by fostering its long-term growth through enhanced productivity and project development Suzuki (2015) demonstrates that pro-cyclical fiscal policy arises due to inefficiencies in the credit market Nonetheless, political economy issues might also explain the reasoning behind cyclical fiscal policy According to Kaminsky et al (2004), developing countries tend to execute a cyclical fiscal strategy, whereas industrialized countries follow an anticyclical model They contend that the inadequacy of international credit markets is the primary cause of cyclical fiscal policy The international credit market's flaws restrict capital supply during economic downturns Therefore, countries cannot stimulate their economies during recessions, and cyclical fiscal policy is the government's only option These results support the hypothesis that when a nation loses access to international financial markets, capital inflows into developing economies "suddenly stop," along with sharp drops in real prices, failed investments, and fiscal austerity measures
Access to domestic and international capital markets allows for fiscal policies that counterbalance economic cycles However, cyclical fiscal policy can hinder long-term growth, especially in nations with low financial intermediation and limited fiscal depth In developing nations, cyclical fiscal policy is common due to insufficient domestic loans to the private sector and a lack of financial asset diversification This limited capital supply prevents adequate injections of funds to sustain the economy during downturns Consequently, governments in these nations often delay fiscal adjustments and hinder investment during prosperous times Credit market deficiencies at the national level also contribute to business cycle fluctuations.
Abbott and Jones (2013) examine the cyclicality of public expenditures as a proxy for OECD fiscal policy They contend that the responsiveness of public spending to fluctuations in the economic cycle is contingent on the degree of political polarization and the limits of public debt In addition, they discover that cyclicality is not limited to the government's aggregate consumption Due to political tensions in the distribution of political power, sub-central government expenditures and inter-government transfers may be more cyclical than central government expenditures Stoian et al (2018) established a framework for assessing the fiscal risk of 28 EU countries from 1990 to 2013 The data indicate that the Czech Republic, Greece, France, Italy, Malta, Portugal, and the United Kingdom had the greatest coefficients of financial vulnerability over the period studied Eyraud et al (2017) evaluated fiscal procyclicality, excessive deficits, erroneous budget structures, and poor adherence to government budget rules in a sample of 19 euro area nations over a period of 16 years Lewis (2009) employed time series analysis to investigate the cyclicality, inertia, and effects of EU membership on the fiscal policies of Central and Eastern European nations The results indicate that the budget balances respond to stabilizing economic activity, are less stable than those of Western Europe, and that, beginning in 1999, the EU membership process creates financial losses for countries in this region
Many studies have provided evidence for the hypothesis that political variables contribute to the procyclicality of fiscal policy Talvi and Vegh (2005) record the adoption of cyclical fiscal policy in emerging nations, which is mostly due to policy distortions In their model for achieving a budget surplus, the application of tax reduction measures is detrimental to developing nations since the tax base in developing nations is highly volatile Consequently, the government should pursue a fiscal policy that is opposite to the business cycle Large changes in fiscal income are the cause of cyclical fiscal policy, as these oscillations are a result of political dynamics These authors argue that the political pressure to spend the budget surplus grows convexly as the surplus grows The political pressure to spend is considerable during times of volatility when there are significant variations in the tax base, as is frequently the case in developing nations As a result, fiscal policy is more procyclical when there are significant tax base movements Because there are fewer savings to smooth out the business cycle during bad economic times due to the low latent propensity to save, fiscal policy tends to be more cyclical during good economic times Calderón and Schmidt-Hebbel (2008) demonstrated that the model predicts a positive correlation between output volatility and fiscal policy, as highly variable output results in highly volatile tax volatility Alesina et al (2008) concur that credit-constrained nations can result in a bias for cyclical fiscal policy; nonetheless, credit limitations are indicative of weak political institutions Budget restrictions during economic downturns indicate potential market developments Consequently, the nation's capacity to obtain financing on the market would be hampered Even if governments have access to funds, their borrowing costs will be unreasonably high, preventing them from stimulating the economy when it is most needed
Political dynamics and the quality of political governance appear to be the primary determinants of fiscal policy cyclicity in developing nations Few studies have examined the relationship between political factors, such as political regime, and the quality of political institutions in regulating fiscal policy's responsiveness to the business cycle In addition to political considerations, Calderón et al (2016) contend that the responsiveness of fiscal policy to the volatility of the business cycle is largely contingent on the quality of institutions Both developed and developing economies with more developed political structures are more likely to pursue anticyclical rather than procyclical macroeconomic policies Ilzetzki and Végh (2008), Ilzetzki (2011), and Halland and Bleaney (2011) find that the quality of political institutions influences the execution of countercyclical fiscal policy positively Céspedes and Velasco (2014) demonstrate that enhancing institutional quality will assist in easing cyclical fiscal policies in wealthy developing nations Institutions and politics determine the procyclical nature of fiscal policy Tornell and Lane (1999) imply that when productivity rises, redistributive effects grow due to rivalry among interest groups for publicly owned resources Although the issue of fiscal policy cyclicality is not directly addressed in their model, it follows that government expenditure in developing nations will likely be cyclical due to the increase in available resources during economic expansions
Both democratic and non-democratic developing nations use fiscal strategies that correspond to the business cycle In democratic societies, however, improved institutional quality is essential for governments to rein in cyclical fiscal policies Navarat (2020) examines 63 developing nations between 1980 and 2013 and demonstrates conclusively that cyclical fiscal policy exists in both democracies and non-democracies Institutional improvement plays a significant role in limiting cyclical fiscal policy, and these behaviors are more prevalent in democracies than in non-democracies Additionally, fiscal policy tends to be less cyclical in well- established and stable democracies Both democratic and non-democratic emerging nations implement a cyclical fiscal strategy, although the higher the institutional quality, the less cyclical the public expenditure Thus, improved institutional quality is an instrument for preventing a strictly cyclical fiscal policy Additionally, democratic countries perform institutional quality-enhancing acts to a greater extent than non-democratic countries, within the limits of cyclical fiscal policy The fiscal policies of more stable and advanced democracies are less likely to fluctuate with the business cycle Countries tend to adopt a less cyclical fiscal policy as institutional quality improves Additionally, a democratic environment exhibits higher institutional quality improvement in the implementation of cyclical fiscal policy than a non-democratic environment Despite their low institutional quality, democratic governments tend to have fewer cyclical fiscal policies than non- democratic governments The maturity and stability of democracies permit countries to make fewer cyclical public expenditures than the majority of populous nations Politicians cannot deny that politics and economics are interconnected For democratic and non-democratic developing nations to transition away from pro- cyclical fiscal policy, improvements in the quality of political institutions and regime stability are crucial
Woo (2009) gives an argument that is slightly different In his theoretical model, fiscal policy becomes more procyclical when there is greater heterogeneity in the interests of different socioeconomic groups As an indicator of unequal benefits, income inequality, as measured by the GINI coefficient, is always a crucial variable in cross-country assessments of fiscal policy procyclicality While the variables that measure the past frequency of a country's defaults and the volatility of capital flows have no bearing on the results of fiscal policy, they are procyclical According to Easterly (2001), communities split into factions are more likely to become redistributive, whereas civilizations that share a culture are more likely to forge consensus for development Other factors for cyclical fiscal policy include various types of social polarization, such as inequality in income, education, and political power Lane (2003) investigates the impact of business cycles on the fiscal policy of OECD nations and demonstrates that cyclical fiscal policy is more prominent in nations with separation of political power Woo (2009) examines the impact of the business cycle on social polarization in income distribution, education, and fiscal policy He observed that public spending is more volatile the more polarized the income In addition, fiscal policy tends to be procyclical if policymakers have less patience
Another major factor impacting fiscal policy is the economy's degree of openness: economies with more trade openness tend to be more susceptible to external shocks and can employ more aggressive fiscal policy (Rodrik, 1998) Similarly, it was discovered that capital account openness influences fiscal stability, as foreign capital tends to flow in (out) during expansionary fiscal policy (recession), hence affecting the cost of funding countercyclical fiscal policies (Aghion and Marinescu, 2008) Studies also indicate that in advanced economies, fiscal policy is more suited to changes in the business cycle, as these tendencies are visible in nations with higher levels of financial development and the government is advised by major organizations (Talvi and Vegh, 2005; Frankel et al., 2011; Acemoglu et al., 2013; Fatas and Mihov, 2013)
LITERATURE REVIEW BETWEEN PUBLIC DEBT AND ECONOMIC
Numerous empirical studies have been conducted on the effect of public debt on economic growth, with varying results Despite the fact that some research has indicated that public debt slows economic growth, other studies have concluded that public debt actually helps to promote it
2.4.1 Literature review of the negative impact of public debt on economic growth
Public debt significantly influences economic growth External debt has been found to have a negative impact, as noted by Reinhart and Rogoff (2010, 2012), Chong et al (2010), and Mohd et al (2013) Similarly, public debt restricts access to savings and capital, according to Diamond (1965) Aizenman et al (2007), Adam and Bevan (2005), and Saint-Paul (1992) further establish the negative correlation between public debt and economic growth.
Between 1961 and 2013, Gómez-Puig and Sosvilla-Rivero (2017) evaluated the long-term relationships between public debt and GDP growth rates in both EU countries Using an autoregressive distributional delay (ARDL) model, an empirical technique on annual data, the authors conclude that public debt has a negative impact on the long-term GDP growth rates of euro area member states
While examining the relationship between public debt and GDP growth using a sample of 111 OECD and developing countries over eight five-year periods from 1970 to 2010, Ahlborn and Schweickert (2016) came to the conclusion that the link between public debt and GDP growth varies significantly between countries due to the fiscal efficiency of each economic system Using a range of statistical techniques, including time-fixed effects, ordinary least squares (OLS), and two- stage combined least squares random effects, Ahlborn and Schweickert (2016) found that public debt has a significant negative impact on GDP growth rates
According to Yeasmin and Chowdhury (2014), in Bangladesh, debt has a major negative impact on economic growth The external debt servicing load in Bangladesh retards GDP growth by 1.3% If considerable reductions in foreign debt are anticipated, Clements et al (2003) show that the growth of per capita income in highly indebted poor countries (HIPCs) will increase by around 1 percentage point per year Babu et al (2014) found that external debt has a considerable negative influence on GDP per capita growth in the East African Community (EAC) Malik et al (2010) predict that economic growth will decline as external debt increases
Using the instrumental variable technique, Panizza and Presbitero (2013) examined the effect of public debt, as a ratio of public debt to GDP, on real GDP per capita growth in a sample of OECD nations In all analyzed economies, Panizza and Presbitero (2013) find a negative association between the public debt-to-GDP ratio and real per capita GDP growth
Research suggests that high public debt negatively impacts GDP growth in the short term Szabo (2013) found that a 1% increase in the debt-to-GDP ratio leads to a 0.027% decrease in annual GDP growth Égert (2012) similarly observed a negative correlation between public debt and GDP growth in industrialized economies Afonso and Jalles (2011) also reported that public debt hindered GDP per capita growth and productivity in developing and developed countries.
1970 to 2008, utilizing both synthetic time series and OLS cross-time series They discovered a statistically significant negative relationship between public debt and GDP per capita growth in all economies studied
Reinhart and Roggof (2010) concluded in their analysis of sustainable economic growth with varying levels of public debt, based on data from 44 countries over a 40-year period (1970–2009), that the association between public debt and economic growth is weak, with a share of GDP less than 90 percent As a result of the rising trend of government spending, the problem of public debt continues to deteriorate High government spending fosters long-term economic expansion As consumption exceeds income, the budget deficit will expand in size The government can raise loans from domestic or international sources to pay the deficit Although the financial situation may improve, it is very susceptible to changes in the current economic climate and the level of public debt
Due to the massive balance of payments impact of the mid-1970s oil crisis, indebted countries are battling with their enormous debt; this has a negative effect on economic growth as emerging economies attempt to maintain growth and strive to complete development projects (Stambuli, 1998) As the government borrows short-term and invests extensively in long-term initiatives, it is difficult for them to collect the revenues necessary to meet their debt obligations (Krumm, 1985)
In a group of emerging countries (Armenia, Azerbaijan, Belarus, Bulgaria, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Romania, Tajikistan, and Ukraine), Shkolnyk et al (2018) demonstrate that the negative impact of external debt on economic growth is statistically significant at the 5% confidence level only for Armenia, Azerbaijan, Belarus, Kazakhstan, and Moldova
Additionally, excessive debt may impact economic growth via channels, primarily by inhibiting investment High amounts of external debt may impede the implementation of policy measures such as fiscal adjustment and trade liberalization by the government This reluctance would have a detrimental impact on economic growth by generating a less favorable macroeconomic policy environment This impacts both quantity and investment efficiency Investors may prefer short-term capital projects over long-term capital projects if they are uncertain about the debtor's ability to repay A compromise that can diminish investment returns and impact economic growth (Pattilo et al., 2002) Kharusi and Ada (2018) discovered a statistically significant negative relationship between Oman's external debt and economic growth from 1990 to 2015
Siddique et al (2016) use an automatic distribution delay (ARDL) model with control variables for trade, population, and capital formation to observe whether debt as a ratio of public debt to GDP affects growth in 40 indebted countries from 1970 to 2007 The authors find that the debt variable has a negative and statistically significant effect on GDP in both the short and long run, in line with prior expectations They also emphasize that increasing levels of debt have a detrimental effect on economic growth in indebted nations, as a significant portion of their output is spent to repay foreign lending institutions; this discourages investment
Snieka and Burksaitiene (2018) use least squares regression (OLS) and autoregression (AR) with panel data to look at how changes in real public debt, real private debt, and falling home prices affect GDP in 24 EU countries The minor euro area countries were removed from the analysis since the volatility of financial services affected the fluctuations of their small economies In the 24 examined European Union nations, the negative impact of public debt growth on the economy is significant when measured with a lag of zero, one, or two years
Lim (2019) examines the relationship between debt and growth when total private and state debt is considered The sample consists of 41 nations from 1952 to
2016 The research makes use of a vector autoregression (VAR) model Lim discovered a negative correlation between the rate of overall debt increase and the rate of economic growth
Abubakar and Suleiman (2020) build an analytical model that evaluates the impact of public debt on economic growth in 37 OECD nations using two-stage least squares regression In contrast to previous research, the authors of this study analyze both the long-term and short-term effects of public debt on economic growth The findings indicate that public debt has a substantial, permanent, and temporary positive effect on economic growth The extent of the negative permanent effect of debt exceeds the favorable temporary benefit In addition, not all nation groups receive transitory positive impacts, while all country groups experience persistent negative consequences
Asteriou, Pilbeam, and Pratiwi (2020) investigate the short- and long-term relationships between public debt and economic growth in 14 Asian nations between 1980 and 2012 The authors employ an ARDL model and a group mean (MG) estimator to ensure consistency between short-run and long-run relationships
THE BASIS OF DESIGNING EMPIRICAL RESEARCH MODEL
Previous research has demonstrated that many emerging nations tend to embrace pro-cyclical fiscal policies During economic downturns, governments reduce expenditures and raise taxes, while during economic expansions, they increase spending and reduce taxes The cyclical nature of fiscal policy is deemed unsatisfactory for both developed and developing countries During a recession, private consumption and investment diminish as a result of decreased demand, and they will worsen if governments undertake contractionary policies Similarly, cyclical fiscal policy causes the economy to overheat during periods of economic expansion The economy becomes overly optimistic as a result of tax cuts, more government spending, and higher aggregate demand from the private sector There is a lot of evidence that emerging countries use cyclical fiscal policy, even though its implementation is not desirable
Previous studies have attempted to explain why economies, particularly developing economies, elect to pursue cyclical fiscal policies There are two primary explanations for this: first, cyclical fiscal policy resulting from inefficiencies and credit limits on international credit markets (Gavin and Perotti, 1997; Kaminsky et al., 2004; Caballero and Krishnamurthy, 2004; Calderón et al., 2010; Aghion et al., 2014) The immaturity of these developing nations' credit markets makes their fiscal policies cyclical Emerging countries will utilize a limited variety of credit instruments in the event of negative economic shocks, based on their ratings, as shown in Latin American countries during times of crisis Periods of IMF loan utilization are significantly more frequent than typical periods (Gavin and Perotti, 1997) Alberola et al (2006) also confirmed the cyclical nature of Latin America's fiscal policy, arguing that the region's financial vulnerability is not only attributable to outstanding public debt levels but also to fluctuations in financial conditions and their effect on the financial performance of financial institutions The second approach holds that political variables, such as the distortion of political regimes, the quality of political institutions, or political polarization, are the root problem of cyclical fiscal policy (Calderón and Hebbel 2008) Studies focus on identifying factors that may contribute to the procyclicality of public spending, examining theories related to social inequality (Woo, 2009), key structural countries (Alesina et al., 2008), and imperfect credit markets (Gavin and Perotti, 1997) The results show that political factors and social inequality are associated with cyclical government expenditures for the entire group of countries analyzed in the EU, in both cross-country regression and table data
Prior studies have concentrated primarily on government spending as a proxy for fiscal policy The proxies of government revenue have not been taken into good consideration due to the dearth of information on revenue and tax rates for developing nations Numerous studies and theories have been conducted on the cyclicality of fiscal policy in emerging nations According to Talvi and Végh (2005), regression is the most effective tool for measuring the fiscal policy reaction to the business cycle In order to construct regressions, the dependent variable must be identified as an outcome of fiscal policy, government spending, or the fiscal balance, which are the most frequently employed variables The evolution of the GDP in several forms (logarithmic or growth rate) is also often employed to measure business cycle changes
Although it would be good to monitor the evolution of tax collections in order to more accurately evaluate the cyclical aspects of countries' fiscal strategies, However, tax-related variables in the sample are frequently inconsistent over the long term Additionally, depending on the country sample examined, additional significant factors may also have an impact on tax revenues, such as tax evasion and the shadow economy, the effects of elections, government regulation of tax collection, or consumption Even though some aspects may be defined, the information data of the countries under examination is of dubious reliability
This study is founded on the budget deficit-related theory that explains why public debt can be detrimental to economic growth According to this hypothesis, an increase in the 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 international 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 decline 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 hand, rising debt levels might cause investors to be concerned that a country would not be able to pay its creditors Getting investors out of the nation's debt might cause an increase in interest rates since bigger returns must be provided to creditors for them 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 Financial crises induced by excessive debt have resulted in substantial economic costs for a number of nations over time (Reinhart and Rogoff, 2010)
In contrast, the debt balancing hypothesis is the main tenet of the growth- optimizing public debt threshold theory put forth by Sachs (1989) and Krugman (1988) According to Krugman (1988), when the public debt is below a particular level, the government concentration impact will outweigh the investment effect; therefore, raising the public debt stimulates economic growth Krugman (1988) states that economic growth can only occur when an increase in efficient public spending substitutes for a decline in private spending However, Krugman (1988) believes that public debt will have a negative influence on economic growth above a certain level since the plus-attraction effect is greater than the private attraction effect The author contends that the crowding-out effect arises when government loans to cover fiscal deficits lower the quantity of capital that can be provided to the private sector, hence decreasing overall national investment In a similar vein, Sachs (1989) argues that lower levels of public debt boost economic growth, but above a certain threshold, high levels of public debt increase economic instability via future tax hikes The author contends that extended economic uncertainty slows investment and consumption, reduces employment, and slows the pace of output growth due to the crowding effect
Studies on the impacts of excessive public debt have not yet yielded a consistent outcome, and additional research is required on this topic, particularly with the calculation of the diverse effects of high and persistent public debt on economic growth across countries Existing empirical research indicates a nonlinear and concave functional link between public sector debt and economic expansion (Panizza & Presbitero, 2014) This suggests that public debt and growth have an inverted U-shaped connection, so that when a particular threshold level of public debt is exceeded, the positive effect becomes negative However, it should be noted that the projected threshold values do not provide a growth projection target level It is acceptable to believe that the study provides concrete evidence of the nonlinear relationship between public debt and economic growth in this scenario Instability in debt dynamics may raise the probability of detrimental effects on capital accumulation and productivity growth, which may have a negative influence on economic growth Consequently, the study can contribute to a better understanding of the problem of excessive public debt and its impact on economic activity
Numerous empirical studies have examined the association between governmental debt and economic growth Nonetheless, the empirical data about the asymmetric effect, the public debt threshold, remains equivocal and inconsistent Most research indicates that public debt below a particular threshold has a favorable impact on economic growth (Reinhart and Rogoff, 2010; Baum et al., 2013; Woo and Kumar, 2015; Taylor et al., 2012; Irons and Bivens, 2010; Pescatori et al., 2014; Rankin and Roffia, 2003; Mencinger et al., 2015; Bexheti et al., 2020) Surprisingly few studies have investigated how public debt and the nonlinear impact of public debt affect economic growth in developing nations (Mencinger et al., 2015; Checherita and Rother, 2010; Bexheti et al., 2020) Emerging nations have encountered a variety of issues, including war, political instability, hyperinflation, massive public debt, and financial catastrophe In transition, these nations provide a fascinating case study, particularly on the relationship between public debt and economic growth Therefore, the purpose of this research question is to investigate the effect of Vietnam's public debt on economic growth To analyze the relationship between public debt and economic growth, we suggest the four hypotheses listed below:
H1: Fiscal policy has a causal impact on the economic cycle in Vietnam H2: Vietnam's fiscal policy responds positively to the economic cycle
H3: The public debt hypothesis does not have a linear influence on economic growth, but public debt has an asymmetric effect on economic growth in Vietnam
H4: The hypothesis that a decrease in public debt by a specific amount has a positive effect on economic growth, whereas a rise in public debt by the same amount has a negative effect on economic growth in Vietnam
To examine the asymmetric relationship between Vietnam's public debt and economic growth, we employ NARDL econometric models and methodologies Several studies examining the nonlinear effect of public debt and its effect on economic growth in transition countries provide the basis of this study's primary premise (Mencinger et al., 2015; Checherita and Rother, 2010; Bexheti et al., 2020).
RESEARCH METHODOLOGY
RESEARCH MODEL
A downgrade regression is a multivariable regression in which the coefficient matrices are subject to constrained conditions Johansen estimated the models ∆Y t and Yt-1 depending on the ∆Y t-1 , ∆Y t-2 , , ∆Y t-p+1 :
Y = ∆Z*E +u 1 Using OLS to estimate the matrices D and E:
D=(D1, D2,…, Dp-1) = ∆Y∆Z'(∆Z∆Z') -1 E=(E1, E2,…, Ep-1) = Y∆Z'(∆Z∆Z') -1 The residuals R0 and R1 of the equation:
R0t and R1t are the residuals at t:
The VAR model that is derived and reduced to the model :
Assuming u has a normal distribution, then the rational function of this model depends only on 𝑅 0𝑡 and 𝑅 1𝑡
2𝐿𝑛(|(𝑅 0 + 𝑅 1 (αβ')')'(𝑅 0 + 𝑅 1 (αβ')')|) where k includes all constants after function constraint
The maximum of this CLF is determined The solution is not unique because for each α, β' and any non-degenerate G matrix, are: ∏ = αβ'= αGG -1 β'= α ∗ β'*, with α ∗= αG; β'*= 𝐺 −1 β' is a solution approach
If the matrix Π = αβ' has no constraints, then the maximum is Π = 𝑆 01 𝑆 11 −1
However, the problem is to find the solution corresponding to the association condition, which is r(Π) = r, r is the level of the α matrix and the β' matrix The solution is found by solving the following eigenvalue problem:
Solving the above system of equations will give m eigenvalues 𝜆 𝑖 and m eigenvectors 𝜔 𝑖 Normalize the result: 𝜔′𝑆 11 𝜔 = 𝐼
Sort 𝜆 𝑖 in descending order and select the r eigenvectors corresponding to the r biggest of 𝜆 𝑖 values
Then, the highest plausible estimate of the matrix 𝛽 is provided by the formula:
And the estimation of the matrix 𝛼 is: 𝛼̂ = 𝑆 00 𝐶̂
Logarithmic Maximum Value of CLF function :
The eigenvalues represent the canonical correlation between Yt và Yt-1 This correlation coefficient represents the highest correlation between linear combinations of Yt và Yt-1 The co-integration relations can be seen to be linear combinations of Yt-1 that are maximally correlated with linear combinations of ∆Y 𝑡 under constant circumstances
The VECM model features the form: yt -yt-1 = (A1+ A2+…+Ap - I) yt-1 - (A2+…+Ap) (yt-1-yt-2) - (A3+…+Ap) (yt-2- yt-3)-…- Ap (yt-p+1 -yt-p) + ut Δ yt = Π yt-1 + C1 Δ yt-1 + C2 Δ yt-2+…+ Cp-1 Δ yt-p+1+ ut
The model containing the term Π yt-1 is the error correction part of ECM
If yt has k cointegration relations, then Π has the form: Π = α x β (kxr) (rxk) Then: Δ yt = αβ yt-1 + C1 Δ yt-1 + C2 Δ yt-2+…+ Cp-1 Δ yt-p+1+ ut
Given ECt-1 = β yt-1: non-stationary sequence combinations in yt to a stationary sequence, and ECt-1 represents the residuals of these non-stationary sequence combinations And ECt-1 represents the state of imbalance at time t-1, then α represents the adjustment coefficient of Δ yt when an imbalance arises
To ensure accuracy in regression modeling, time series stationarity is crucial Researchers evaluate and select regression models based on stationarity tests, such as the stationarity of time series test Non-stationary time series are transformed to stationary by differencing at an appropriate order This transformation stabilizes the mean and variance of the time series, allowing for more reliable regression analysis.
The Unit root test, with a 0.05% significance level, found that the Ho hypothesis regarding the presence of a unit root was rejected for all series Thus, the series exhibit stationarity at the same difference order.
When k = 0 (None), p-value =0.0000 < α should reject the hypothesis Ho: r 0 (no cointegration between variables); however, when k = 1 (At most 1), p-value > α should accept the hypothesis Ho: r = 1 The series has interactions with each other
Selecting an optimal model delay is crucial, typically achievable by employing PACF charts or LogL, AIC, SC criteria For this analysis, LR, FPE, AIC, and HQ criteria will guide the identification of the optimal model latency Various information criteria are available for determining model lag, with Johansen (1990) elucidating that the VECM latency is typically one order smaller than the VAR latency, informing the authors' defined hypothesized lag in this study.
To assess the stability of the VECM model, use the AR Root Test to see whether the solutions or eigenvalues are all less than 1 or contained within the unit circle If this is the case, then the VECM model is stable
The tests demonstrate that the stationary series have the same order of difference, and the cointegration test reveals a single cointegration, indicating that the selection of the VECM model was suitable The VECM model is guaranteed to be stable and appropriate for regression when the right latency is used From there, the author draws conclusions based on an analysis of variance decomposition and impulse response functions
In order to determine the stationarity of time series, the author has performed the unit root test The results demonstrated that the data series are stationary with the same level of association: I(1) Therefore, the Engle-Granger test or the Johansen test can be used to determine whether or not the data series are co- intergrated The author employs the VECM method based on the study of Johansen (1990) to test for cointegration if the stationary series have the same order of difference Johansen performs a series of statistical tests to identify the number of linked vectors, including checks for cointegration and tests to find the maximum number of data chain cointegrations The results indicate that the data series are cointegrated The VECM regression model is selected To find the right VECM model and avoid problems like spurious regression or particular errors, it is important to check that the data series are stationary and cointegrated Furthermore, the stationary variables have the same order of difference and are cointegrated, suggesting that a regressive VECM model is required (Granger et al., 1987)
The Vector Error Correction Model (VECM) allows for the simultaneous assessment of short- and long-term causal linkages between variables in a system due to its ability to analyze their interdependence without distinguishing between endogenous and exogenous variables This makes VECM particularly well-suited for datasets with limited time series observations, such as those commonly found in Vietnam.
In regression analysis involving time series data, if the regression model contains both the present values and the lagged values (past values) of the variables, this model is known as the lagged distribution model If the explanatory variables of the model include one or more lagged values of the dependent variable, the model is called an autoregressive model
To ensure accuracy, the NARDL regression model will be employed only after thorough testing, particularly for stationarity of time series Non-stationary time series will be transformed into stationary form by implementing higher-order differencing.
NARDL (Non-linear Auto-Regressive Distributed Lag) permits the determination of the disproportional influence of independent variables on the dependent variable: dYt= m +α1 x dYt−1+α2 xdYt−2 +…+αnxdYt−1 + β0xdXt + β1xdXt−1+…+ βnxdXt−n + β2nxX t−1+ut
Whereas dYt and dXt are the stationary variables after the difference, and ut is the white noise residuals dYt−n and dXt−n are stationary variables at lags
NARDL is used in regression analysis involving time series data:
Xt= A 1 X 𝑡−1 +…+A 𝑞 X 𝑡−𝑞 +ɛ 𝑡 u 𝑡 ɛ 𝑡 are white noises with stationary covariance matrix
Y is regressed against the lagged values of Y itself and other X variables
In terms of financial econometrics, the NARDL model is crucial The purpose of this study is to investigate the effect of Vietnam's public debt on the country's rate of economic expansion using a dynamic regression model with an asymmetrical distribution lag (NARDL):
GDP = f(IRB, USD/VND00, LIA, BMG)
Shin et al (2014) introduced asymmetry in the short run and long run by separating positive and negative explanatory variable coefficients When testing the relationship between asymmetric time series, this model has the benefit of being applicable to real-world settings and applicable in the economics sector Shin et al have developed a long-term asymmetric NARDL regression model: t t t t y = + x + − x + u (1)
VARIABLES DESCRIPTIONS OF THE RESEARCH MODEL
3.2.1 The variables of the model of the relationship between fiscal policy and the business cycle
This study provides a fresh perspective on Vietnam's fiscal policy's response to the economic cycle in terms of public spending The thesis has built a research model with variables indicating the economic cycle and fiscal policy based on Talvi and Végh's (2005) model
Table 3.1 Sources of variables used in the model
Variables Symbol Ratios/ Calculation method
Vietnam production GDP GDP index (%) IMF
LNEXP EXP index, logarithm IMF
LNTAX TAX index, logarithm IMF
Public debts LNLIA LIA index, logarithm IMF
According to the research of Debrun and Kapoor (2011), Furceri and Jalles (2016), and Afonso and Jalles (2013), the size of government spending is frequently regarded as the most significant factor in determining fiscal policy stability Keynes
Economic cycles are characterized by alternating periods of recession and recovery (Mitchell, 1936) These fluctuations in economic growth, as measured by GDP, drive the cycle Government spending, an indicator of fiscal policy, also plays a significant role in shaping economic cycles.
3.2.2 The variables of the model of public debt on economic growth
The research incorporates five critical variables: economic growth (GDP), government spending, lending interest rates, the USD/VND exchange rate, and public debt These variables align with established economic theories and prior research (Mencinger et al., 2015; Checherita and Rother, 2010; Bexheti et al., 2020) Government expenditures, interest rates, and the exchange rate serve as control variables, representing channels through which monetary and fiscal policies can impact economic growth Public debt, encompassing domestic and foreign debt, measures the government's overall borrowing.
Table 3.2 Description of the model variables
GDP Economic growth % Dependent variable
LIA Public debt Logarit Asymmetric variable EXP Government Expenditures Logarit Control variable
IRB Lending rate % Control variable
USD/VND00 USD/VND exchange rate Logarit Control variable
The research encompasses five variables: Economic growth, Public debt, Government expenditures, Lending rate, and the USD/VND Exchange rate There might perhaps be more factors that are deemed relevant for the current investigation Nevertheless, time series models need a substantial quantity of data
The regression procedure might become ineffective when there is a rapid rise in variables in the system
The study examines the non-linear effects of public debt on Vietnam's economic growth Data is collected on a quarterly basis, spanning from the first quarter of 2000 to the first quarter of 2021 Variables are derived from the International Monetary Fund's financial statistics (IFS) Vietnam's gross domestic product (GDP), lending rate as a percentage, public debt, government expenditures, and USD/VND exchange rate are trend variables that have a non-normal distribution, characterized by a significant right skew Research transforms this variable into its natural logarithm form in order to align its distribution with the usual normal distribution, hence satisfying the input data requirements of the model
The following particular model has been created:
RESEARCH DATA
3.3.1 Research data of the model of the relationship between fiscal policy and the business cycle Table 3.3 Descriptive statistics of the variables
Source: Author’s summary and calculation
The data is applicable for the years 2000 through 2021 The percentage of Vietnam's gross domestic product (GDP) is derived from the IMF's international financial data Government Spending Variables, Government Tax Revenue, and Public debt are collected from IMF international financial statistics The government's expenditure, Government tax revenue, and public debt are trend variables that do not have a normal distribution; the deviation must be very large Research is required to convert this variable to logarithmic base natural form so that the variable has a distribution close to the distribution standard and meets the model's input data conditions In addition, the seasonal factor frequently affects variables with an annual frequency Using the Census X12 tool, this study isolates the impact of the seasonal element from the data series
3.3.2 Research data of the model of public debt on economic growth
Table 3.4 shows the descriptive statistics of the variables used in the study, including GDP, EXP, IRB, LIA, USD/VND00 Where GDP, IRB and USD/VND00 are regularly distributed, while EXP has a large standard deviation, a high mean, and a severely skewed Jarque-Bera index
Table 3.4 Descriptive statistics of variables Value
IRB GDP LIA USDVND EXP
Source: Regression result from Eviews10
IMF financial statistics (IFS) quarterly data are used to examine the nonlinear influence of public debt on Vietnam's economic growth over the period from the first quarter of 2000 to the first quarter of 2021 Vietnam's gross domestic product (GDP) and lending rate (IRB) are expressed as a percentage; public debt (LIA), government spending (EXP), and USD/VND00 are non-normally distributed propensity variables, thus they must be transformed to logarithmic form.
RESEARCH RESULTS AND DISCUSSION
EXAMINING THE RELATIONSHIP BETWEEN FISCAL POLICY AND
AND THE BUSINESS CYCLE 4.1.1 Tests of the research model
4.1.1.1 Stationary Test for data series
To ensure credible time series data analysis, stationarity is crucial A stationary time series Yt must exhibit constant mean and variance over time Additionally, the covariance between Yt and Yt-s relies solely on the time interval s, not on the specific time t Failure to meet these stationarity conditions can lead to unreliable regression results.
To test whether Yt is stationary, that means checking whether Yt is a random walk:
If Ho is accepted at significance level α, the time series is non-stationary, whereas if Ho is rejected, the time series is stationary The Dickey-Fuller unit root test was conducted to test the stationary of the series LNEXP and GDP, respectively Results indicate that the series does not stop at d = 0
Table 4.1 Unit root test of data series (d=0)
Augmented Dickey-Fuller test statistic Prob.*
Null Hypothesis: LIA has a unit root 0.5113
Null Hypothesis: EXP has a unit root 0.1692
Null Hypothesis: TAX has a unit root 0.1145
Null Hypothesis: GDP has a unit root 0.0529
The results of the test indicate, with a significance level of α = 0.05, that all accept the Ho hypothesis of the presence of a unit root; therefore, the series EXP, TAX, LIA, and GDP do not stop at the difference d = 0
Table 4.2 Unit root test of data series (d=2)
Augmented Dickey-Fuller test statistic Prob.*
Null Hypothesis: LIA has a unit root 0.0000
Null Hypothesis: EXP has a unit root 0.0000
Null Hypothesis: TAX has a unit root 0.0000
Null Hypothesis: GDP has a unit root 0.0000
The vast majority of economic time series are non-stationary; however, they can be converted to stationary series by the process of difference If a series is non- stationary and stops at a difference of order d, it is referred to as a connected series of order d with the symbol: Yt ͌ I (d) Using the Dickey–Fuller unit root test to examine the stationarity of the LNEXP and GDP series, respectively, at a difference of d = 2
Using a significance level of α = 0.05, the unit root test results indicate that the existence of unit roots in the Ho hypothesis is not supported, hence the series EXP, TAX, LIA, and GDP stop at the second difference level Consequently, if the data series are stationary with the same difference order, then the cointegration test will continue to be conducted
Since the data series are stationary with the same order of difference (d = 2), the Johansen test is performed to check whether the series EXP, TAX, LIA, and GDP are cointegrated or not
Table 4.3 Cointegration test of data series
Unrestricted Cointegration Rank Test (Maximum Eigenvalue)
No of CE(s) Eigenvalue Statistic Critical Value Prob.**
Trace test indicates 1 cointegrating eqn(s) at the 0.05 level
*denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-valuesUnrestricted Cointegrating
Johansen's test results reveal that the time series EXP, TAX, LIA, and GDP exhibit cointegration at the 0.05 significance level, with a p-value of 0.0194 This outcome refutes the null hypothesis that there is no cointegration among these variables.
Thus, when the series are stationary with the same order of difference (d = 2) and Johansen's test shows that the series have cointegration Therefore, the VECM model selected to test the relationship between the economic cycle and the fiscal policy of Vietnam is appropriate
Granger's Wald Tests help determine whether the variables included in the model are endogenous or exogenous and are necessary to be included in the model The variables in the model include EXP, TAX, LIA, and GDP when conducting Granger's Wald tests
Null Hypothesis: Obs F-Statistic Prob
GDP does not Granger Cause EXP
EXP does not Granger Cause GDP
3.31170 0.0416 LIA does not Granger Cause EXP
EXP does not Granger Cause LIA
2.62721 0.0787 TAX does not Granger Cause EXP
EXP does not Granger Cause TAX
0.50411 0.6060 LIA does not Granger Cause GDP
GDP does not Granger Cause LIA
4.15017 0.0194 TAX does not Granger Cause GDP
GDP does not Granger Cause TAX
3.44239 0.0369 TAX does not Granger Cause LIA
LIA does not Granger Cause TAX
Source: Regression Results The results show that at the significance level α = 0.05, EXP has an impact on GDP (5%), GDP has an impact on LIA (5%) and TAX has an impact on GDP
At the significance level α = 0.1, LIA has an impact on GDP (10%) Thus, the variables are all endogenous and necessary to be included in the model
4.1.1.4 Stability Test in the research model
To test the stability of the VECM model, use the AR Root Test to consider whether the solutions or the eigenvalues are not greater than 1 or are not outside the unit circle The VECM model achieves stability
The results show that the solutions are not larger than 1 or are not outside the unit circle, so the VECM model is stable and suitable for regression
Fugure 4.1 Stability test of the model
4.1.2 Results of testing the relationship between fiscal policy and economic growth
After conducting VECM model tests, VECM regression model results are obtained as follows: u = GDP - 0.095912EXP + 1.881209LIA + 26.02291TAX+ 3.100242
In the long run, the volatility of GDP is positively related to the volatility of EXP and inversely related to the volatility of LIA and TAX
Combination of non-stationary sequences into a stationary sequence, and ECt-1 is the residual in that combination ECt-1 = α indicates an imbalance in the t-
1 period; α is the adjustment coefficient when an imbalance occurs in the short run
ECt-1 = -0.910403: A deviation from equilibrium in the previous period by one unit leads to a subsequent adjustment of 91% toward the equilibrium level This adjustment requires more than two periods to fully restore equilibrium.
To analyze the causal relationship between fiscal policy and the business cycle, variance decomposition functions and impulse response functions will be constructed These functions assist in analyzing the direct and indirect impacts of one factor's shock on another This enables the author to properly comprehend their dynamic connection The author uses the Cholesky factor coefficient recommended by Sims (1980) to determine the system's shocks
Figure 4.2 The Impulse Response function of EXP, TAX, LIA, GDP
Source: Regression Results Government spending volatility shocks result in an initial positive response to real GDP, which has a negative effect and is particularly pronounced in the first four periods Given that Vietnam is a developing country, strengthening the economy with money from government spending will increase production and favorably influence economic growth When spending outpaces production requirements starting in the sixth period, the GDP response fluctuates slightly over the long term
The responsiveness of GDP to LIA shocks has continually reversed since the first phase Government borrowing will increase the volatility of interest rates and can have crowding-out effects on the private sector Therefore, fluctuations in public debt will have significant effects on economic growth
Similarly, tax income is one of the indicators of the response of the economy to the state's fiscal policies Increasing tax income is not always conducive to economic growth
When economic growth slows, government spending decreases, and the government increases both public debt and tax collections to cover the deficit
EXAMINING THE IMPACT OF PUBLIC DEBT ON ECONOMIC
GROWTH 4.2.1 Tests of the research model
4.2.1.1 Stationary Test for Data series
To test whether Yt is stationary, Dickey – Fuller test is conducted:
With significance level α = 0.05, if Ho is accepted, the time series is non- stationary; if Ho is rejected, the time series is stationary Applying the Dickey-Fuller test for the data series EXP, GDP, IRB, USD/VND00, and LIA
Table 4.7 Unit root test of data series (d=0) Augmented Dickey-Fuller test statitic t-Statistic Prob.*
Null Hypothesis: GDP has a unit root -2.874037 0.0529 Null Hypothesis: LNUSDVND00 has a unit root -1.026399 0.7404 Null Hypothesis: IRB has a unit root -1.748785 0.4032
Null Hypothesis: EXP has a unit root -2.317600 0.1692 Null Hypothesis: LIA has a unit root -1.534560 0.5113
The test results, with the significance level α = 0.05%, all accept the hypothesis Ho, thus the series GDP, IRB, USD/VND00, EXP, and LIA all do not stop at difference d = 0
Continue to test the stationary of the series GDP, IRB, USD/VND00, EXP, and LIA at the first difference:
Table 4.8 Unit root test of data series (d=1) Augmented Dickey-Fuller test statitic t-Statistic Prob.*
Null Hypothesis: GDP has a unit root -4.759976 0.0002 Null Hypothesis: LNUSDVND00 has a unit root -2.302451 0.0173 Null Hypothesis: IRB has a unit root -8.221248 0.0000
Null Hypothesis: EXP has a unit root -1.424586 0.0466 Null Hypothesis: LIA has a unit root -6.325325 0.0000
The test results with a significance level of α = 0.05% all reject the hypothesis Ho, so that the series GDP, IRB, USD/VND00, EXP, and LIA stop at the first difference Thus, the data series are stopped at the first difference
Table 4.8 displays the outcomes of the initial unit root The results indicate that the series GDP, IRB, USD/VND00, EXP, and LIA stop at the difference I(1) Unit root testing is essential for the NARDL model because the lagged autoregressive model applies stationary series at I(0), I(1), or a combination of I(0) and I(1) The model cannot be applied when any variable stops at second-order I(2) Because the inclusion of variables I(2) invalidates the F-statistic of the cointegration test (Ibrahim, 2015; Ouattara, 2004) In the NARDL methodology, unit root testing is essential The results demonstrate that no series stops at the second order, allowing this research to proceed to the NARDL model
The results show that at the significance level α = 0.05, p-value = 0.0065 < α, so the hypothesis Ho is rejected The model has a suitable functional form for inclusion in the regression
Specification: GDP1 GDP1(-1) GDP1(-2) EXP1_POS EXP1_NEG EXP1_NEG(- 1) IRB1_POS IRB1_NEG IRB1_NEG(-1) LIA1_POS LIA1_NEG USDVND1_POS USDVND1_NEG C
Sum of Sq df Mean Squares
Source: Regression Results 4.2.1.3 The Breusch/Pagan Test
To test the Jarque-Bera test of the residuals and the test of variance, use the Breusch/Pagan test
Table 4.10 The Breusch/Pagan test
Heteroskedasticity Test: Breusch-Pagan-Godfrey
Obs*R-squared 24.91492 Prob Chi-Square(12) 0.0152
Scaled explained SS 48.44180 Prob Chi-Square(12) 0.0000
The results obtained from the Breusch/Pagan test show that at the significance level α = 0.05, p-value = 0.0084 < α should reject the hypothesis Ho The model is not subject to variance
Table 4.11 The NARDL mode Variables constant Std Err t-values P- values
GDP1(-1) 0.181591 0.112907 1.608325 0.1124 GDP1(-2) -0.406895 0.100292 -4.057119 0.0001 EXP1_POS -7.792198 1.478342 -5.270904 0.0000 EXP1_NEG -4.044499 0.943741 -4.285600 0.0001 EXP1_NEG(-1) -3.502798 1.351912 -2.590995 0.0117 IRB1_POS 0.040734 0.123100 0.330899 0.7417 IRB1_NEG 0.169743 0.084964 1.997836 0.0497 IRB1_NEG(-1) -0.194678 0.103401 -1.882748 0.0640 LIA1_POS 0.352669 1.051407 0.335425 0.7383 LIA1_NEG -0.557014 1.071044 -0.520066 0.6047 USDVND1_POS -9.718015 9.086940 -1.069449 0.2886 USDVND1_NEG -3.628589 8.181509 -0.443511 0.6588
Source: Regression Result from Eviews10
Before estimating the NARDL, several tests, including the Ramsey test for the functional problem and the Breusch/Pagan variance test, were conducted Table 4.11 illustrates the NARDL model The results demonstrate that the model does not contain any of the aforementioned flaws; hence, this study can be utilized to estimate NARDL
In addition, the F-statistic is greater than t_BDM in Table 4.12, demonstrating that a long-term relationship exists between public debt and economic growth When a nonlinear co-integration estimate is provided, therefore, the long-run connection can be studied further
Table 4.12 Nonlinear co-integration test Co-integrated test statistics:
Source: Regression Result from Eviews10 4.2.1.5 Short-run and long-run asymmetry testing
The asymmetry test was performed to assess the nonlinear impact of public debt on economic growth According to Table 4.13, WLR = 2.034333 (with the associated probability value of 0.0138) and WLR = 16.74844 (with the accompanying probability value of 0.000) indicate that the public debt influence on economic growth is statistically significant in both the short run and the long run
Table 4.13 Short-run and long-run asymmetry testing Test Asymmetric relationship in the long run
Asymmetric relationship in the short run
Results Asymmetrical relationship Asymmetrical relationship
Source: Regression Result from Eviews10 4.2.1.6 The Wald Test
In contrast, the Wald test is utilized to assess the asymmetric influence of public debt on economic growth The results of Table 4.14 indicate that at the equilibrium level C3C5 (with a corresponding probability value of 0.02062), the influence of public debt on economic growth is statistically significant in both the short and long term
Table 4.14 Wald test in the short run and the long run
Source: Regression Result from Eviews10
4.2.2.1 Asymmetrical impact of public debt on economic growth in the long-run
The modeling results presented in Table 4.15 indicate that economic growth can return to long-term equilibrium following each short-term shock to public debt A one percent increase in public debt results in negative variations of 0.209970 percent in economic growth However, a one percent decrease in public debt results in positive variations of 1.174791 percent in economic growth
Table 4.15 Asymmetrical impact of public debt on economic growth in the long-run Value Coef Std Err t-Statistic P
EXP1_POS** -7.849069 1.487857 -5.275420 0.0000 EXP1_NEG(-1) -7.515130 1.512799 -4.967698 0.0000 IRB1_POS** 0.066491 0.130088 0.511122 0.6109 IRB1_NEG(-1) -0.032338 0.097176 -0.332774 0.7403 LIA1_POS** -0.209970 1.054558 0.199107 0.8428 LIA1_NEG** 1.174791 1.250243 -0.939650 0.3507 USDVND1_POS** -10.80028 14.13692 -0.763977 0.4475 USDVND1_NEG** 4.574194 9.746040 0.469339 0.6403 D(GDP1(-1)) 0.415322 0.100250 4.142873 0.0001 D(EXP1_NEG) -4.022579 0.960627 -4.187452 0.0001 D(IRB1_NEG) 0.140201 0.084974 1.649934 0.1036
Source: Regression Result from Eviews10 4.2.2.2 Accumulation of residuals in the NARDL model
Figure 4.3 Plot of cumulative sum (CUSUM) residuals
Source: Regression Result from Eviews10
Figure 4.4 Plot of adjusted cumulative sum (CUSUMSQ) residuals
Source: Regression Result from Eviews10
Figures 4.3 and 4.4 illustrate the implementation of a stability test on the predicted parameters using Cusum and Cusumsq The purpose of this test was to determine the statistical significance of the NARDL model The findings indicate that both Cusum and Cusumsq fall inside the critical lines at a 5% significance level, suggesting that the model is stable and not susceptible to unforeseen disturbances or structural breakdowns
4.2.2.3 Asymmetric impact of changes in public debt on economic growth
Figure 4.5 Asymmetric cumulative dynamic multiplier graph of public debt and economic growth
Source: Regression Result from Eviews10
Figure 4.6 Asymmetric cumulative dynamic multiplier of USDVND exchange rate on economic growth
Source: Regression Result from Eviews10
To study in depth the asymmetric effect of changes in public debt on short- and long-term economic growth, the author undertakes a cumulative dynamic multiplier analysis derived from the NARDL model The influence of positive and negative changes in public debt on economic growth is depicted in Figure 4.3 Economic growth responds more quickly and promptly to an increase in public debt than to a decrease in public debt during the short term In the long term, however, growing public debt has negative impacts on economic growth, while lowering public debt has positive effects on economic growth; this means that an increase in public debt will, to some extent, have a negative influence on economic growth Public debt and economic growth have an inverted U-shaped relationship Consequently, public debt has both short- and long-term asymmetric effects on economic growth In nations with emerging economies, such as Vietnam, budget deficits and rising public debt are nevertheless prevalent In the early phases of an economy's development, the production process requires substantial budgetary capital support However, if the operational and management policies of the economy are ineffective over the long term, the budget deficit, public debt, and economic pressure will likely increase Increasing public debt has greater negative effects on the economy at this time Consistent with earlier empirical studies: Kumar and Woo (2010); and Reinhart and Rogoff (2007) (2010) Especially in developing nations such as Vietnam, the link between public debt and economic growth is asymmetrical Throughout the whole cycle in question, the difference between the growing and decreasing changes (red dashed line) is statistically significant Thus, public debt has both short- and long-term unbalanced consequences for economic growth
Figure 4.5 illustrates the effect of favorable USDVND exchange rate fluctuations on economic expansion In the short term, economic growth responds to an increase in the exchange rate more quickly and visibly than it does to a reduction in the exchange rate On the other hand, in the long run, both an increase in the exchange rate and a fall in the exchange rate will have a good effect on the growth of the economy A neutral exchange rate will also have a positive impact on economic growth This is consistent with the State Bank of Vietnam's present exchange rate control system The exchange rate is one of the government's tools for achieving its monetary policy and economic growth objectives
Budget deficits and rising public debt are nevertheless common in nations with growing economies, such as Vietnam The budget must constantly provide a sizable quantity of capital assistance to the economy's manufacturing process in its early phases However, if the economy's operational and management strategies are ineffective, it will typically drag down the budget deficit, increase public debt, and pressure the economy Increasing public debt has greater negative effects on the economy at this time Consistent with prior empirical research by Checherita- Westphal and Rother (2010), Kumar and Woo (2010), and Reinhart and Rogoff (2005), the current study's findings correspond to Checherita-Westphal and Rother (2010), Kumar and Woo (2010) (2010b) Especially in developing nations such as Vietnam, the link between public debt and economic growth is asymmetrical
The management of Vietnam's public debt has effectively aligned with the established goals and yielded notable outcomes in reality The significant success made in this accomplishment may be ascribed to the incremental enhancement of the legislative framework and debt management strategies, which have played a role in the steady refinement of the government's debt This statement illustrates the ongoing improvement in the quality of public debt management by the state in Vietnam These enhancements have been directed towards greater rigor and efficiency, therefore contributing to the development of a more advanced legislative framework for managing state debt Furthermore, these efforts accord with worldwide standards and practices in debt management Nevertheless, Vietnam's public debt management is subject to significant restraints and limitations First and foremost, notwithstanding the favorable changes in the debt composition, public debt continues to entail a range of inherent hazards Furthermore, the advantageous policies pertaining to borrowing from foreign sources have become less attractive in light of the increased expenses connected with such borrowing The development of the domestic capital market remains relatively weak, while non-bank financial organizations encounter various obstacles Moreover, the government has challenges in consolidating the allocation of medium- and long-term bonds at favorable interest rates Furthermore, the allocation of investment capital, which encompasses concessional foreign loans provided by the government, continues to exhibit a sluggish pace Additionally, it is worth noting that the government is now seeing a rise in direct debt repayments as a result of the maturation of public debt accumulated in previous years As a result of this trend, more government spending is going toward paying down debt as a percentage of total income in the state budget at the moment Furthermore, there is a lack of variation in the maturity of government securities issuance Hence, the government's ability to raise funds may encounter distinct challenges throughout certain periods
Research, test, and empirically evaluate the impact of public debt on economic growth The study also analyzed the current debt situation of Vietnam's public sector As a result, the NARDL regression model shows that economic growth has a nonlinear relationship with public debt Regression results show that low public debt has a positive impact on economic growth, while increasing public debt has a negative impact on economic growth in Vietnam The results are consistent with general theoretical assumptions and previous literature Therefore, the government needs to create a business-friendly environment to attract more investment and support economic growth
The asymmetric impact of public debt on economic growth highlights the importance of improving economic management This can take the form of improved efficiency in the use of resources to effectively reduce the debt burden Policymakers in Vietnam should play an effective role in monitoring the public debt situation and should pay close attention to avoid the risk of debt accumulation Furthermore, there is a need to improve and effectively manage government consumption, as this will lead to an improvement in public debt Vietnam may need to try to follow some basic principles of economic practice, such as always spending to the extent possible As a developing country, Vietnam has a high average level of public debt; therefore, policymakers need to develop a sound financial plan to ensure that accumulated public debt does not cause an overload for future generations The Vietnamese government may need to improve its use of fiscal and monetary policy to reduce its dependence on public debt
CONCLUSION AND POLICY IMPLICATIONS
CONCLUSION
The research examined the fiscal policy instruments used throughout the analyzed time frame and concluded that the notion of developed nations using countercyclical policies while developing countries adopting procyclical policies is fully consistent with the situation seen in Vietnam Consequently, fiscal policy in the majority of emerging nations was aligned with the business cycle over the studied period Public spending, public debt, and tax revenues are examined as possible contributors to the cyclical nature of fiscal policy According to the findings, public debt and tax revenue change negatively with economic growth, whereas government spending varies positively with it
The fiscal policy of developing nations is aligned with the economic cycle, and the research findings are compatible with empirical studies of such nations Vietnam is a developing country when the economic growth rate is positive; thus, it must boost production resources to keep up with the development momentum, and physical resources are crucial for the economy's expansion They should instead transition into a condition of wealth accumulation, in contrast to the position of developed countries, which have excess potential
Empirical evidence also demonstrates that exceeding a certain threshold in public debt has detrimental effects on economic growth The provided Wald test findings provide strong evidence in favor of a symmetrical correlation between public debt and economic growth, both in the long and short term The study findings have ramifications for economic policy Furthermore, the management of public debt is crucial for sustaining Vietnam's enduring economic expansion Amidst the aftermath of the COVID pandemic, when inflation is high and economic growth is delicate, the implementation of structural reforms and technical advancements may be crucial in establishing a robust, ecologically sustainable, and resilient economy Amidst the COVID-19 epidemic, governments should acknowledge the pressing issue of growing budget deficits in most nations Public debt has emerged as a strategy to address the situation and sustain labor services Hence, it is essential for governments to have effective rules for monitoring the levels of profitable debt This would enable them to effectively address economic shocks and debt crises, safeguard employment, make lucrative investments, and maintain the long-term viability of the economy
The government should use insights gained from past debt crises to rectify the inherent weaknesses in the economy, such as enhancing investment and establishing robust sectors via the implementation of new economic growth conditions Moreover, during periods of turmoil, a low ratio of debt to GDP may be beneficial as it assists in mitigating the effects of any unexpected disturbances In order to achieve economic and social stability, it is essential to have a robust social safety net that can effectively assist individuals in alleviating the economic hardships they face during periods of crisis Hence, government loans should be specifically directed towards the expansion and diversification of the nation's economy in order to foster sustainable economic growth in the long run The process of economic diversification would not only mitigate the adverse effects of significant changes in export prices on macroeconomic stability but also expand the country's sources of income, enhancing its capacity to meet its financial commitments promptly
Domestic borrowing supports economic growth, currency markets, inflation management, and foreign exchange conservation Repayments act as reinvestments, driving domestic investment Vietnam should prioritize infrastructure investments to address capital market savings gaps and leverage lower interest rates Foreign debt's positive impact requires sound macroeconomic policies and robust institutions To bridge resource gaps and foster long-term growth, Vietnam needs private capital and financial reforms: reducing fiscal deficits, increasing domestic revenue, investing in infrastructure, and strengthening governance The government must address debt, enhance creditworthiness, manage inflation, and boost production.
The study findings also illustrate a persistent non-linear correlation between public debt and economic growth over an extended period of time This highlights the need for cultivating a robust, forward-thinking, heterogeneous economy built around core competencies The study findings further support the claim that expansionary fiscal policy has effectively stimulated long-term inflation Hence, it is essential to synchronize fiscal and monetary policies in order to attain comprehensive macroeconomic stability Failure to do so may result in detrimental consequences, impacting not just individual variables but also the broader economy The primary factors contributing to fiscal imbalance, which compel policymakers to resort to debt financing, are the excessive growth of the public sector, elevated administrative expenses, unmanageable debt service costs, and substantial expenditures on national defense Hence, in order to mitigate the negative consequences of inflation, particularly its extended duration, the research suggests implementing measures to regulate the expansion of the money supply, decrease administrative expenses, and reduce fiscal deficits Governments are advised to adopt infrastructure asset recycling methods, which include transferring existing infrastructure to the private sector or establishing Public-Private Partnership arrangements These measures aim to improve infrastructure and address the increasing budget deficits
In times of economic distress, credit constraints and the complexity of credit markets make it difficult or impossible for developing nations to get adequate finance The credit rating of Vietnam, which is already not very high, will be further constrained and at a disadvantage when the economy enters a crisis Therefore, the economy's access to credit will be restricted, and the government must reduce spending and impose a strict fiscal policy
In developing countries such as Vietnam, the majority of a government's spending goes toward two categories of expenditures: salaries for government employees and investment costs When the economy is in a recession and the government is compelled to reduce spending, it must choose between reducing investment and wages Most governments will be compelled to reduce investments due to pressure On the other hand, long-term government spending is closely tied to economic expansion Without public projects, it is difficult for the government to sustainably raise taxes
In fact, when the economy is in a recession, the trade-off between governments in developing countries lowering investment and recurrent spending may lose the potential to stimulate future economic growth When the economy is in a recession and the government is forced to implement contractionary fiscal policy, it should proceed with caution when deciding to reduce investment spending
As Vietnam experiences significant economic expansion, its growing nation requires substantial capital to support its development While the government's expansionary fiscal policy aims to stimulate growth, it is imperative to prioritize efficient and impactful investment strategies By strategically allocating capital resources, the government can avoid inefficient spending and maximize the return on investments, fostering long-term economic sustainability and progress.
Current research on the relationship between Vietnam's fiscal policy and the economic cycle focuses primarily on qualitative analysis and situational evaluation
In addition to evaluating the real condition of Vietnam's fiscal policy and economic cycle over the past few years, this study also employs a quantitative model that spans a reasonably long length of time The degree of interaction between variables is increasing in complexity as the level of economic and financial market development advances Therefore, it is crucial for policymakers to conduct research that uses variables over an extended period of time because this will provide a new viewpoint and, maybe, a more accurate representation of the situation Finally, it can illuminate the proper selection of the most effective fiscal policy operating mechanism for the expansion of the Vietnamese economy
Vietnam's market-oriented economy faces ongoing challenges in defining the role of market forces Empirical evidence suggests that Vietnam's fiscal policies exhibit procyclical characteristics, aligning with theoretical frameworks and previous research on developing economies These findings highlight the need for policymakers to carefully consider the impact of fiscal policy on economic cycles in Vietnam, ensuring appropriate measures to mitigate potential risks and promote sustainable economic growth.
The study investigates and analyzes the direct influence of public debt on economic growth in Vietnam The results indicate a disproportional association between public sector debt levels and short- and long-term economic growth The results are consistent with recent empirical studies indicating a nonlinear relationship between public debt and economic growth in some nations The NARDL model demonstrates that public debt and yearly GDP growth have a non- linear relationship with the probable critical threshold; surpassing the public sector debt ratio hurts developing economies like Vietnam
This empirical research of Vietnamese economies demonstrates that public debt has a favorable effect on economic growth at low levels Nonetheless, this influence grows more negative when public debt increases over a certain threshold Consequently, the results are compatible with hypothesis H1
The research results are also compatible with hypothesis H2, which is based on the broad theoretical premise that a higher level of public debt is detrimental to economic growth Increasing governmental debt has a detrimental impact on economic expansion The results are consistent with prior empirical evidence regarding developing and emerging nations
POLICY IMPLICATIONS
In developing economies, the lack of automated stabilizing mechanisms and limited unemployment insurance programs necessitate reliance on government spending and salaries as the primary source of fiscal policy The prevalence of indirect taxes, as opposed to direct personal income taxes, further constrains fiscal policy's effectiveness due to low individual earnings Consequently, fiscal policy in developing countries exhibits a high sensitivity to economic fluctuations, highlighting the need for tailored and timely interventions to mitigate economic volatility.
In prosperous times, governments in developing nations spend more on investments and social benefits, but they reduce expenditure during recessions In periods of economic expansion, it is also difficult for governments to reduce expenditure on health, education, and infrastructure
Several nations with fragile economies have shown sluggishness in meeting their debt repayment commitments, necessitating the use of debt restructuring measures Moreover, even in nations where the public debt can be effectively handled, the debt obligations continue to constitute a growing portion of the government's income Analysts are concerned that, if not addressed, the present surge in debt levels might reignite a series of financial crises in heavily indebted nations, similar to those seen in the past Of concern is the fact that Vietnam's current economic slowdown has occurred at the same time as a rise in the country's debt levels, which started following the global financial crisis
Attaining the Sustainable Development Goals requires substantial expenditures in infrastructure, human capital, and climate change resilience, among other things Nevertheless, poor nations have few alternatives when it comes to raising public funds or enticing private investments Hence, these nations use debt as a means to fulfill their capital needs for expansion, but at a level that is not sustainable and poses a threat to economic progress Governments engage in domestic or foreign borrowing to address both immediate and long-term resource deficits and foster economic expansion in situations when government revenues are inadequate to meet expenditure requirements Hence, public debt serves as a crucial instrument for governments to effectively fund capital creation, sustain public expenditure, and foster economic expansion, particularly in circumstances where implementing growth taxes and curtailing public expenditures prove challenging In the case of an abrupt and unexpected catastrophe, public debt may serve as a safeguard to minimize the need for swiftly raising taxes in order to fund increased expenditures
The matter of sustainable development is a crucial global concern, particularly for emerging nations whose economies rely on natural resources and the environment Public debt levels in middle-income nations such as Vietnam have seen significant and fast growth in recent years High levels of public debt have a significant impact on the economic prospects of many emerging and developing countries, which can result in over-indebtedness and debt traps with long-lasting effects Moreover, the act of repaying debt incurs significant costs since it exhausts already limited financial assets Consequently, the emphasis shifts from pursuing chances for expansion to the repayment of debts
Historically, governments have classified growing economies such as Vietnam as having financial difficulties resulting from significant debt acquired from both local and international sources Emerging economies have demonstrated that governments' inability to fund essential expenditure programs solely with tax revenues is the main cause of their dependence on debt Consequently, governments are compelled to engage in borrowing primarily to invigorate the economy by redirecting cash from foreign investors into the local sector However, policymakers have consistently expressed concern about the total cost of debt that Vietnamese governments have incurred The primary inquiry revolves around the potential impact of public debt on economic growth, determining whether it is advantageous or unfavorable Although it is recognized that public borrowing is unavoidable in countries such as Vietnam to fund financial operations, it is important to remember that public debt is a two-sided issue that might have consequences The advantage lies in the potential for investment returns to fully balance the debt over time, or at the very least, for the subsequent welfare gains to surpass the associated expenses Alternatively, the outcome will manifest as a burdensome cycle of indebtedness from which it is arduous to extricate oneself
The increasing debt load of a nation severely impedes its capacity to build its economy This is because the repayment of debt incurs more costs and may eventually become unsustainable for the nation in debt, restricting its capacity to attain its fiscal and monetary objectives Government borrowing may have a detrimental effect on private investment, leading to a decrease in future production and profits and posing a threat to living standards Excessive public debt poses challenges to implementing procyclical fiscal policy, potentially leading to heightened volatility and diminished economic growth
There are numerous reasons why fiscal policy in developing countries tends to be procyclical For instance, government spending (G) grows when aggregate demand (AD) is extremely high Large capital flows poured into the country during the time of economic growth, putting pressure on the exchange rate to rise and boosting exports Consequently, these investments improve the government's tax collection The government perceives a rise in the budget due to the wealth effect, higher public investment, and the expansion of state projects During periods of economic expansion, gasoline prices rise, putting pressure on the overall price level Tax revenues also rise, and the government continues to boost spending Additionally, political pressure generates incentives for the government to boost spending during periods of growth
When capital leaves the economy, the opposite occurs until the economy enters a condition of weakness, leading to a sudden halt The government was compelled to decrease the deficit by cutting spending due to a sharp decline in capital expenditures Consequently, when the economy suffers, G falls, and fiscal policy is procyclical In poor nations, government spending is mostly allocated to two categories: civil servant wages and investment expenditures When a country's economy is in a recession and the government is compelled to slash its budget, it often chooses, for political reasons, to reduce investment rather than wages Most governments are frequently under pressure, and the simplest response is to reduce investment, particularly in emerging nations
Government spending in the form of investments, such as the construction of roads, bridges, and infrastructure, etc., is correlated with economic expansion over the long term Without these public initiatives, it would be challenging to sustainably raise taxes Occasionally, investment cuts are inevitable, but in developing nations, government spending cuts can stimulate future growth
The disproportional impact of public debt on economic growth emphasizes the need for enhanced economic management To effectively minimize the debt burden, this can take the form of enhanced resource utilization efficiency To prevent the risk of debt accumulation, policymakers in Vietnam should play a significant role in monitoring the state of public debt Additionally, there is a need to enhance and properly manage government expenditures, as this will reduce the public debt The findings of the regression indicate that the money supply into the economy has an asymmetric effect on economic growth, which indicates that the money supply does not fully boost economic growth; rather, an excessive money supply would hinder economic growth Vietnam may need to adhere to some fundamental economic concepts, such as spending as little as is feasible Vietnam has a high average public debt as a developing nation; thus, authorities must create a strong financial plan to avoid burdening future generations In order to minimize its reliance on public debt, the Vietnamese government may need to reform its fiscal and monetary policy
External borrowing can stimulate economic growth in developing countries by bridging savings-investment gaps However, debt dynamics play a critical role: low debt servicing costs relative to investment returns foster growth, while high costs can stifle it Vietnam strategically utilizes both internal and external borrowing to address these gaps, supporting economic growth and key macroeconomic factors such as investment, consumption, education, and health.
Annual interest payments on public debt have a detrimental impact on economic growth In recent years, a number of emerging nations have actively pursued internal debt to replace external debt This has resulted in the emergence of a second issue, namely the problem of rising and substantial domestic debt Internal loan delinquencies can have significant effects on the economy The interest rates involved will surpass the foreign debt and devour a large percentage of the government's revenue This can also cause competition between the government and the private sector, resulting in private sector investment being crowded out This is a regular occurrence in developing nations such as Vietnam
The topic of debt and economic growth in Vietnam implies that there is a direct correlation: more debt is detrimental to economic growth In addition, seeking a bigger public debt to encourage economic growth is a poor policy choice, as it might result in higher taxes, a decline in private investment, and an increase in consumer spending Moreover, the data indicate that for some countries in transition, such as Vietnam, the current level of debt may have had a negative impact on GDP growth, as the average debt-to-GDP ratio is currently above the threshold for GDP public debt Countries with debt levels above the threshold should consider decreasing their public debt to ensure that their national revenue is sufficient to repay the debt If a country is insolvent and needs more financial resources, increasing the tax rate to replace the debt is not a viable alternative
This module informs governments in transitioning nations about the asymmetric impact of public debt on economic growth and the point at which public debt becomes a drag on growth The study also warns transition country authorities that targeting higher debt levels to enhance growth is not a feasible policy option Countries in transition with debt levels exceeding their GDP must take measures not just to stabilize their public debt but also to reduce it over the medium and long term Therefore, the only prudent strategy for policymakers in countries is to manage public debt below GDP in order to absorb external shocks that are unpredictable and may impact economies
STABILITY TEST OF THE MODEL
4.1.2 Results of testing the relationship between fiscal policy and economic growth
After conducting VECM model tests, VECM regression model results are obtained as follows: u = GDP - 0.095912EXP + 1.881209LIA + 26.02291TAX+ 3.100242
In the long run, the volatility of GDP is positively related to the volatility of EXP and inversely related to the volatility of LIA and TAX
Combination of non-stationary sequences into a stationary sequence, and ECt-1 is the residual in that combination ECt-1 = α indicates an imbalance in the t-
1 period; α is the adjustment coefficient when an imbalance occurs in the short run
ECt-1 = -0.910403 shows that if the previous period imbalance is 1 unit, at the first period, the dependent variable will adjust back to the equilibrium of 91% Thus, it takes a total of more than two periods to restore equilibrium
To analyze the causal relationship between fiscal policy and the business cycle, variance decomposition functions and impulse response functions will be constructed These functions assist in analyzing the direct and indirect impacts of one factor's shock on another This enables the author to properly comprehend their dynamic connection The author uses the Cholesky factor coefficient recommended by Sims (1980) to determine the system's shocks
Figure 4.2 The Impulse Response function of EXP, TAX, LIA, GDP
Source: Regression Results Government spending volatility shocks result in an initial positive response to real GDP, which has a negative effect and is particularly pronounced in the first four periods Given that Vietnam is a developing country, strengthening the economy with money from government spending will increase production and favorably influence economic growth When spending outpaces production requirements starting in the sixth period, the GDP response fluctuates slightly over the long term
The responsiveness of GDP to LIA shocks has continually reversed since the first phase Government borrowing will increase the volatility of interest rates and can have crowding-out effects on the private sector Therefore, fluctuations in public debt will have significant effects on economic growth
Similarly, tax income is one of the indicators of the response of the economy to the state's fiscal policies Increasing tax income is not always conducive to economic growth
When economic growth slows, government spending decreases, and the government increases both public debt and tax collections to cover the deficit
Variance decomposition analysis in the VECM model differentiates the contributions of time series to forecast variables The findings align with impulse response functions, highlighting the significance of fiscal policy in business cycles Government expenditure variations account for 3% of GDP forecast error, with persistent impact Public debt volatility exceeds 4% of GDP volatility Tax revenue has a substantial impact on economic growth, exceeding 10% Vietnam's fiscal policy emphasizes tax collection, consistent with these findings.
Period S.E D(GDP,2) D(EXP,2) D(LIA,2) D(TAX,2)
The study results are consistent with earlier research Fiscal policy in developing countries is pro-cyclical (Acemoglu et al., 2013; Fatas and Mihov, 2013) Developing nations frequently lack stabilizing instruments like unemployment insurance and social benefits The majority of developing nation expenditures consist of recurring government expenses and wages In developing nations, indirect (trade and consumption) taxes are more prevalent than direct taxes (income taxes) In addition, people in these nations have low incomes; therefore, the personal income tax contributes a small amount to the government budget Consequently, fiscal policy in developing nations is very procyclical
In emerging economies such as Vietnam, the government increases expenditure on investments and social benefits during booming periods and reduces spending during recessions In periods of economic expansion, it is also difficult for governments to reduce expenditure on health, education, and infrastructure When the economy is in a fragile position The government was compelled to decrease the deficit by cutting spending due to a sharp decline in capital expenditures Therefore, when the economy suffers, fiscal policy will reduce government spending
4.2 EXAMINING THE IMPACT OF PUBLIC DEBT ON ECONOMIC
GROWTH 4.2.1 Tests of the research model
4.2.1.1 Stationary Test for Data series
To test whether Yt is stationary, Dickey – Fuller test is conducted:
With significance level α = 0.05, if Ho is accepted, the time series is non- stationary; if Ho is rejected, the time series is stationary Applying the Dickey-Fuller test for the data series EXP, GDP, IRB, USD/VND00, and LIA
Table 4.7 Unit root test of data series (d=0) Augmented Dickey-Fuller test statitic t-Statistic Prob.*
Null Hypothesis: GDP has a unit root -2.874037 0.0529 Null Hypothesis: LNUSDVND00 has a unit root -1.026399 0.7404 Null Hypothesis: IRB has a unit root -1.748785 0.4032
Null Hypothesis: EXP has a unit root -2.317600 0.1692 Null Hypothesis: LIA has a unit root -1.534560 0.5113
The test results, with the significance level α = 0.05%, all accept the hypothesis Ho, thus the series GDP, IRB, USD/VND00, EXP, and LIA all do not stop at difference d = 0
Continue to test the stationary of the series GDP, IRB, USD/VND00, EXP, and LIA at the first difference:
Table 4.8 Unit root test of data series (d=1) Augmented Dickey-Fuller test statitic t-Statistic Prob.*
Null Hypothesis: GDP has a unit root -4.759976 0.0002 Null Hypothesis: LNUSDVND00 has a unit root -2.302451 0.0173 Null Hypothesis: IRB has a unit root -8.221248 0.0000
Null Hypothesis: EXP has a unit root -1.424586 0.0466 Null Hypothesis: LIA has a unit root -6.325325 0.0000
The test results with a significance level of α = 0.05% all reject the hypothesis Ho, so that the series GDP, IRB, USD/VND00, EXP, and LIA stop at the first difference Thus, the data series are stopped at the first difference
Table 4.8 displays the outcomes of the initial unit root The results indicate that the series GDP, IRB, USD/VND00, EXP, and LIA stop at the difference I(1) Unit root testing is essential for the NARDL model because the lagged autoregressive model applies stationary series at I(0), I(1), or a combination of I(0) and I(1) The model cannot be applied when any variable stops at second-order I(2) Because the inclusion of variables I(2) invalidates the F-statistic of the cointegration test (Ibrahim, 2015; Ouattara, 2004) In the NARDL methodology, unit root testing is essential The results demonstrate that no series stops at the second order, allowing this research to proceed to the NARDL model
The results show that at the significance level α = 0.05, p-value = 0.0065 < α, so the hypothesis Ho is rejected The model has a suitable functional form for inclusion in the regression
Specification: GDP1 GDP1(-1) GDP1(-2) EXP1_POS EXP1_NEG EXP1_NEG(- 1) IRB1_POS IRB1_NEG IRB1_NEG(-1) LIA1_POS LIA1_NEG USDVND1_POS USDVND1_NEG C
Sum of Sq df Mean Squares
Source: Regression Results 4.2.1.3 The Breusch/Pagan Test
To test the Jarque-Bera test of the residuals and the test of variance, use the Breusch/Pagan test
Table 4.10 The Breusch/Pagan test
Heteroskedasticity Test: Breusch-Pagan-Godfrey
Obs*R-squared 24.91492 Prob Chi-Square(12) 0.0152
Scaled explained SS 48.44180 Prob Chi-Square(12) 0.0000
The results obtained from the Breusch/Pagan test show that at the significance level α = 0.05, p-value = 0.0084 < α should reject the hypothesis Ho The model is not subject to variance
Table 4.11 The NARDL mode Variables constant Std Err t-values P- values
GDP1(-1) 0.181591 0.112907 1.608325 0.1124 GDP1(-2) -0.406895 0.100292 -4.057119 0.0001 EXP1_POS -7.792198 1.478342 -5.270904 0.0000 EXP1_NEG -4.044499 0.943741 -4.285600 0.0001 EXP1_NEG(-1) -3.502798 1.351912 -2.590995 0.0117 IRB1_POS 0.040734 0.123100 0.330899 0.7417 IRB1_NEG 0.169743 0.084964 1.997836 0.0497 IRB1_NEG(-1) -0.194678 0.103401 -1.882748 0.0640 LIA1_POS 0.352669 1.051407 0.335425 0.7383 LIA1_NEG -0.557014 1.071044 -0.520066 0.6047 USDVND1_POS -9.718015 9.086940 -1.069449 0.2886 USDVND1_NEG -3.628589 8.181509 -0.443511 0.6588
Source: Regression Result from Eviews10
Before estimating the NARDL, several tests, including the Ramsey test for the functional problem and the Breusch/Pagan variance test, were conducted Table 4.11 illustrates the NARDL model The results demonstrate that the model does not contain any of the aforementioned flaws; hence, this study can be utilized to estimate NARDL
In addition, the F-statistic is greater than t_BDM in Table 4.12, demonstrating that a long-term relationship exists between public debt and economic growth When a nonlinear co-integration estimate is provided, therefore, the long-run connection can be studied further
Table 4.12 Nonlinear co-integration test Co-integrated test statistics:
Source: Regression Result from Eviews10 4.2.1.5 Short-run and long-run asymmetry testing
The asymmetry test was performed to assess the nonlinear impact of public debt on economic growth According to Table 4.13, WLR = 2.034333 (with the associated probability value of 0.0138) and WLR = 16.74844 (with the accompanying probability value of 0.000) indicate that the public debt influence on economic growth is statistically significant in both the short run and the long run
Table 4.13 Short-run and long-run asymmetry testing Test Asymmetric relationship in the long run
Asymmetric relationship in the short run
Results Asymmetrical relationship Asymmetrical relationship
Source: Regression Result from Eviews10 4.2.1.6 The Wald Test
In contrast, the Wald test is utilized to assess the asymmetric influence of public debt on economic growth The results of Table 4.14 indicate that at the equilibrium level C3C5 (with a corresponding probability value of 0.02062), the influence of public debt on economic growth is statistically significant in both the short and long term
Table 4.14 Wald test in the short run and the long run
Source: Regression Result from Eviews10
4.2.2.1 Asymmetrical impact of public debt on economic growth in the long-run
The modeling results presented in Table 4.15 indicate that economic growth can return to long-term equilibrium following each short-term shock to public debt A one percent increase in public debt results in negative variations of 0.209970 percent in economic growth However, a one percent decrease in public debt results in positive variations of 1.174791 percent in economic growth
Table 4.15 Asymmetrical impact of public debt on economic growth in the long-run Value Coef Std Err t-Statistic P
EXP1_POS** -7.849069 1.487857 -5.275420 0.0000 EXP1_NEG(-1) -7.515130 1.512799 -4.967698 0.0000 IRB1_POS** 0.066491 0.130088 0.511122 0.6109 IRB1_NEG(-1) -0.032338 0.097176 -0.332774 0.7403 LIA1_POS** -0.209970 1.054558 0.199107 0.8428 LIA1_NEG** 1.174791 1.250243 -0.939650 0.3507 USDVND1_POS** -10.80028 14.13692 -0.763977 0.4475 USDVND1_NEG** 4.574194 9.746040 0.469339 0.6403 D(GDP1(-1)) 0.415322 0.100250 4.142873 0.0001 D(EXP1_NEG) -4.022579 0.960627 -4.187452 0.0001 D(IRB1_NEG) 0.140201 0.084974 1.649934 0.1036
Source: Regression Result from Eviews10 4.2.2.2 Accumulation of residuals in the NARDL model
Figure 4.3 Plot of cumulative sum (CUSUM) residuals
Source: Regression Result from Eviews10
Figure 4.4 Plot of adjusted cumulative sum (CUSUMSQ) residuals
Source: Regression Result from Eviews10