Page 81 - ES 2020-21_Volume-1-2 [28-01-21]

64 Economic Survey 2020-21 Volume 1

Box 6: CAuSALiTY TESTS ON PANEL DATA OF EMEs AND
ADVANCED ECONOMiES

To confirm the direction of causality using formal statistical tests, pairwise Dumitrescu Hurlin
Panel Causality Test was carried for the sample of EMEs and advanced economies. The test
allows the coefficients to be different across countries. This test simply runs standard Granger
Causality regressions for each cross-section individually. The lag order is assumed to be identical
for all countries.
The test finds evidence of causality from Growth to Debt for the sample of EMEs. However, for
the sample of Advanced countries, the test is not able to establish any causal relationship between
Change in debt-to-GDP and growth.
Sample 1- Emerging market Economies Sample 2- Advanced economies

Time period: 1981-2018 (Unbalanced) Time period: 1981-2018
Countries: India, China, Indonesia, Malaysia, Countries: Canada, France, Germany, Greece,
Thailand, Philippines, Vietnam, Turkey. Italy, Spain, UK, USA, Japan
H : Real growth rate does not cause Change in H : Real growth rate does not cause Change in
0
0
Debt/GDP for all cross sections. Debt/GDP for all cross sections.
Rejected at 5% level of significance Not rejected.

H : Change in Debt/GDP does not cause Real H : Change in Debt/GDP does not cause Real
0
0
growth rate for all cross sections. growth rate for all cross sections.
Not rejected Not rejected.

Data source: IMF

CROwDiNG OuT DuE TO PuBLiC EXPENDiTuRE?

2.21 So far, we have established a clear direction of causality between growth and debt for
countries where the growth rates are high; specifically, growth leads to debt sustainability and
not vice versa in these countries. This direction of causality is, however, not clear in the case of
countries where the growth rate is low. This is because higher growth enables the IRGD to be
negative and thereby ensuring debt sustainability. We now examine the potential mechanisms
that explain behind the causal effect from growth to debt sustainability and not vice versa for
India.

2.22 Conceptually, the plausible link from higher incremental debt to lower growth rate
is based on potential crowding out of private investment and the Ricardian Equivalence
Proposition (REP). REP states that forward-looking consumers, who are also assumed to be