Growth in a time of austerity: evidence from the UK
| Author | Paul Middleditch,Juergen Amann |
| Published date | 01 September 2017 |
| Date | 01 September 2017 |
| DOI | http://doi.org/10.1111/sjpe.12132 |
GROWTH IN A TIME OF AUSTERITY:
EVIDENCE FROM THE UK
Juergen Amann* and Paul Middleditch**
ABSTRACT
This paper uses an empirical approach to test the specific causal relationship
between debt and growth in the UK, in the context of the debate surrounding the
use of a policy known as austerity measures. This time series perspective makes
use of more recent Granger causality and cointegration tests that allow for non-
stationarity in macroeconomic time series data in the presence of structural
breaks. Controlling for exogenous shocks associated with the period around the
financial crisis, we find no evidence of a causal relationship between economic
growth and public debt for the UK.
II
NTRODUCTION
The European sovereign debt crisis of 2010 brought an increase in uncertainty
for global financial markets already unnerved by the financial crisis that had
begun a couple of years earlier. A concern with the ability of the governments
across the Eurozone to service their public debt gave significant contribution
to a second pan-European slump in economic activity. In July of the same
year, the incoming UK coalition government came into power during an envi-
ronment requiring immediate measures to calm financial markets. In order to
achieve this, the freshly elected coalition announced a programme that has
come to be known as austerity, a commitment to oversee the long-term reduc-
tion of public spending as a percentage of GDP.
1
Since this time and some
years forward, we have seen growth return to more normal levels in the UK,
raising the question of whether or not the recent recovery can be attributed in
a direct way to the change in fiscal discipline.
This paper is motivated by the seminal contribution of Reinhart and Rogoff
(2010) whose study has focused a debate around the issue of fiscal discipline
and its relation to the rate of growth in income. This influential study found a
direct link between public debt and economic growth, more specifically the
*
The University of Nottingham
**
University of Manchester
1
See Konzelmann (2014) for an in-depth discussion on the concept of austerity as a mea-
sure of fiscal discipline and how this measure has transformed from being a means to achieve
macroeconomic stabilisation to becoming an objective in its own right.
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12132, Vol. 64, No. 4, September 2017
©2017 Scottish Economic Society.
349
existence of a debt threshold (of 90%) at which economic growth is signifi-
cantly impeded. In an environment of surging public debt and crumbling
growth rates, international organisations and policy-makers have found their
own interpretation of studies such as this to legitimise rigorous public spend-
ing cuts (Minea and Parent, 2012). Consequently, the effectiveness and legiti-
macy of the policy of austerity has been widely discussed in both the public,
economic and political arenas. The findings in Reinhart and Rogoff (2010)
have also provoked an extensive discussion in the field of applied economics
and are not without reinforcement, in fact several other panel-type studies
such as Cecchetti et al. (2011), Casni et al. (2014), Baum et al. (2013) and
Woo and Kumar (2015) offer fair to mixed support of the debt-to-GDP
threshold hypothesis.
Contrary to this, authors such as Minea and Parent (2012) have found that
the coefficients between debt and growth predict a positive relation, Panizza
and Presbitero (2014) found no statistical causal link and Kourtellos et al.
(2013) a similar relation in terms of debt thresholds that only exists in low
democracy countries. The Reinhart and Rogoff (2010) study has also been
challenged on technical grounds through the work of Herndon et al. (2014)
who replicated the study and discovered coding errors, selective exclusion of
data and unconventional weighting methods. Controlling for these issues, their
replication study finds that the effect of the 90% debt-to-GDP threshold on
growth becomes neglectfully small. A recent study by Puente-Ajov
ın and
Sanso-Navarro (2015) makes use of panel Granger causality tests across 16
OECD countries allowing for cross-country heterogeneity and cross-sectional
dependence. Using annual data over a 30-year time span ending in 2009, they
find little evidence of a causal relation between debt and growth for all the
countries examined. In the UK, in particular and in line with Bell et al.
(2015), they find no evidence of a causal relation between government debt
and growth.
In this paper, we statistically test the proposition that there is a direct rela-
tion between the level of public debt and the rate of GDP growth, motivated
by the natural experiment brought about by the UK government’s policy of
austerity announced in 2010. We do this by applying a time series causality
testing framework to a bidirectional system of GDP growth and the same
public debt measure used in the literature. Our approach deviates from the
main literature in that it offers a time series perspective that focusses on the
UK, uses high-frequency data, comfortably spans the financial crisis from
1995M01 to 2013M12 and puts special emphasis on the presence of structural
breaks in our testing framework. For our empirical investigation, we first
make robustness checks for structural interventions using endogenous break-
point and unit root test methods to eliminate structural bias in our analysis.
Secondly, employing an augmented Toda and Yamamoto (1995, TY proce-
dure from now on) Granger causality testing procedure and the Johansen
et al. (2000) cointegration framework that both allow for the presence of
structural breaks, we draw a conclusion on the bidirectional relation between
debt and growth.
350 JUERGEN AMANN AND PAUL MIDDLEDITCH
Scottish Journal of Political Economy
©2017 Scottish Economic Society
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