eThesis - Kauppakorkeakoulun sähköiset gradut

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The purpose of the present thesis is to examine the dynamic interactions between total debt and GDP. In particular, the growth rates are studied in real terms. Total debt is defined as the sum of credit market liabilities of household, business, financial, foreign, federal government, state government and local government sectors.

The methodology of this study is based on time-series regression analysis, in which a structural VAR model is estimated. Then, the dynamic interactions are studied with Granger causality tests, impulse response functions and forecast error variance decompositions. The data is based on the United States from 1959 to 2010 and it is organized quarterly.

The main finding of this study is that real total debt growth affects real GDP growth, but there is no feedback from real GDP growth to real total debt growth. The response of real GDP growth to a shock in real total debt growth seems to be transitory, but the level effect might be persistent. In both cases the effect is in the same direction. Thus, a positive shock in the growth rate of real total debt has a transitory positive effect on real GDP growth rate, but may have a persistent positive effect on the level of real GDP.

The results of this study imply that economic growth typically requires accumulating total debt. In other words, economic growth is very difficult to achieve when total debt is reduced. At the time being, the private sector of the United States is already heavily indebted and, hence, it seems likely that it is unwilling or unable to accumulate more debt. Consequently, during a recession the public sector should borrow to stimulate the economy and enhance the repayment ability of the private sector. Furthermore, the United States can be considered as a financially sovereign country, which does not face an income constraint, it can also clear all its debt obligations at any given time and, thus, it cannot drift into insolvency. However, present financial institutions set constraints for public borrowing especially in Europe. Consequently, there might be a need to redesign European institutions in order to facilitate public borrowing.