Financial Stress and the Impact of Public Debt on UK Growth in High versus Low-Growth Regimes: 1850-2013
Using a long historical dataset, we estimate a Threshold Vector Autoregression (T-VAR) model for the UK based on a financial stress measure, the debt-to-GDP ratio, borrowing costs and real GDP growth. Our model allows for the impact of debt/GDP to vary between periods of high and low economic growth. We find that financial stress depresses growth much more in the low as opposed to the high-growth regime. We also find that positive shocks to debt/GDP depress economic growth and raise borrowing costs; again, the impact is much stronger when growth is low. This is an important finding as economists and policy-makers are currently debating whether it makes sense to proceed swiftly with fiscal consolidation when economic conditions remain weak.
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