Essays on Fiscal Policy, Public Debt and Financial Development

Abstract: This thesis consists of three distinct articles that can be read separately. Each one has been awarded a chapter of its own. The independence of these chapters should not be taken as meaning that they are unrelated. Besides belonging all to the subfield of macroeconomics, they share the common feature of being inherently economic policy oriented. The title of the first article is "Fiscal Policy and Private Consumption in Industrial and Developing Countries" and has been accepted for publication in the Journal of Macroeconomics (tentatively scheduled for Volume 29, Number 4 (December 2007)). It empirically studies the effects of fiscal policy shocks on private consumption. Further, it investigates if the initial financing needs of the government or previous fiscal deficits affect that relationship. I use yearly data between 1970 and 2000 for forty countries, of which 19 are industrialized and 21 are underdeveloped. In general, the estimation results seem to indicate that government consumption shocks have Keynesian effects for both industrial and underdeveloped countries. In the case of tax shocks, the evidence is mixed. Furthermore, there is no evidence that favor the hypothesis of expansionary fiscal consolidations (non-Keynesian effects). "Debt and Economic Growth in Developing and Industrial Countries" is the title of this, second, article. It empirically explores the relationship between debt and growth for a number of underdeveloped and industrial economies. For underdeveloped countries, we find that lower total external debt levels are associated with higher growth rates, and that this negative relationship is driven by the incidence of public external debt, and not by private external debt. Regarding the channels through which debt accumulation affects growth, we find that this is mainly driven by inhibiting capital accumulation. We find only a weak connection between external debt and total factor productivity growth. In the case of private savings rates, the results are mixed. In addition, we do not find any support for an inverted-U shape relationship between external debt and growth. For industrial countries, we do not find any significant relationship between gross government debt and economic growth. The title of the third article is "Industry Diversification, Financial Development and Productivity-Enhancing Investments". It theoretically studies the role of the financial system in promoting macroeconomic stability and growth. It also explains endogenously the development of the financial system as part of the growth process. The productive sector engages in R&D activities, and finances its activities through access to the financial system. While vertical innovation spurs economic growth, horizontal innovation creates new industry sectors, and thus enhances industry diversification. Higher industry diversification deepens the financial system by improving its ability to finance the productive sector. Economies that are more diversified, and thus more financially developed, have higher growth rates and are less volatile. There is a role for the government to subsidize innovation, especially horizontal innovation.