What Really Drives GDP Growth?

Jivraj Karwa and Nathan Johnson

INTRODUCTION

“Stimulus” and “steroids” are loaded words, but they have more in common than it seems at first blush.

A catch-all word for a lot of different, more nuanced interventions? Check.

Performance enhanced when using? Check.

Potential side effects? Double check.

But perhaps the biggest similarity is that both words assume growth is a guaranteed result. But what you’re using matters.

In this case, not all stimulus is created equal.

Generally, modern economics looks at two broad policy levers for driving economic growth – fiscal stimulus (otherwise known as government spending), and monetary stimulus (central bank asset growth). There are myriad details and variations to each – how the money is spent, what central banks should buy, etc. – but the core components remain.

But which of those two is the better driver or indicator of growth?

To create an accurate picture of growth patterns in a global economy, we needed a reliable cross-section of the economy. With five larger economic bodies – US, Euro Region, England, China, Japan – and a number of smaller, developing economies as our dataset, we dug in.

Here’s what we found.

BACKGROUND

From 2000-2019, government spending as a share of GDP for developed economies grew overall by 2% (Figure 1)^[1], with a significant peak in government spending due to the 2008 financial crisis, then a steady decline to pre-crisis levels, with an upswing once again underway at the time of this writing. Developing economies in the same period saw government spending growth of 11% from 22% to 33% (Figure 2).^[2] Developing economies also saw a sharp increase due to the financial crisis, but unlike the developed economies, there was no subsequent drop-off but a continual steady increase after the financial crisis.

This increased drastically during the financial crisis when governments and central banks increase spend and balance sheets during the crisis period. Figure 3 also depicts an overall growth of >250% over a six year period, with a CAGR of 22% from 2006-2011.^[3] For the same economies during 2000-2019, aggregate nominal GDP has grown from $30T to $68T at a CAGR of 4%. ^[4]

Fig. 1 – Share of Govt. Spend in GDP (Developed economies)

Fig. 2 –  Share of Govt. Spend in GDP (Developing economies)

Fig. 3 – Total Central Bank Assets ($Tn)

Fig. 4 – Nominal GDP ($Tn)

The relationship between the share of government spend in GDP, growth in the assets of the central bank of the country, and growth in non-Government GDP with future growth in non-Government GDP is unclear. But these figures combined depict two key points – growth in government spend as a share of GDP and growth in central bank assets. For the latter, one could reasonably assume an even higher number after 2020’s data is finalized.

*Economies considered: US, England, Euro Region, Japan, China, India, Indonesia, Canada, Turkey, Mexico, Brazil, South Korea

OBJECTIVE 

Our objective is to understand the impact of fiscal and monetary activities on future growth in non-Government GDP. Given the general trend among economies to favor monetary stimulus over fiscal stimulus, our cross-section of developed and developing economies lays the bedrock for statistical analysis. From there, we might see if we can infer which of our two main economic policy levers has a better track record of driving growth.

Through our analysis, we also hoped to gain answers to some key questions.

1. How well – if at all – does the non-government GDP growth rate of developing economies reflect the effect of fiscal activities vs monetary activities?
2. What is the main factor of influence for future growth of non-Government GDP?
3. What is the impact of non-Government GDP growth rate in developing vs developed economies?
4. In developed economies, which variable has the strongest impact on the future non-Government GDP growth rate?

RESEARCH AND ANALYSIS

Of several independent variables considered (Table 1), growth in non-Government GDP shows a strong correlation – both positive and negative – with three variables from prior year: share of Government spend in GDP, growth in central bank assets, and nominal GDP growth rate. The correlation did not hold going back two years, however, making prior year the favorable time frame for comparison (Figure 5).

Table 1

Fig. 5 – Correlations of Independent Variables with Non-Government GDP Growth Rate

Running CARTree regression on the data, non-Government GDP growth rate changes with independent variables as shown in table 2. Finally, Figure 6 depicts the CARTree analysis in more detail, confirming our hypothesis from our correlation analysis. Central bank asset growth rate from prior year for developed economies are negatively correlated to this year’s nominal GDP growth rate. The initial node segregates according to prior year non-government GDP growth rate, with developed economies less than 8.3% and developing economies greater (operating on a general assumption that developing economies tend to have higher GDP growth rates). The approximate percentage split of developed to developing economies is 62% to 38%, respectively.

All this supports an intriguing observation: the maturity of developed economies reduces the perceived impact from either kind of stimulus.

Table 2

Figure 6 – CARTree Regression Decison Tree for Developed and Developing Economies

CONCLUSIONS

Thanks to this analysis, we can confidently make a few assertions regarding our earlier guiding questions. First, non-Government GDP growth rate of developing economies doesn’t reflect the effect of fiscal activities strongly, while there’s a moderate impact of monetary activities. Second, future growth of non-Government GDP mainly depends on the growth stage at which the economy lies. If the current non-Government GDP growth rate is high, the subsequent year growth is also likely to be higher. Going from developing to developed economies, the impact of non-Government GDP growth rate lessens.

Crucially, we noted the future non-Government GDP of the developed economies declines with an increase in the country’s central bank assets and share of Government spending in the GDP. Of variables assessed, growth in a country’s central bank assets has the strongest impact on the future non-Government GDP growth rate, followed by share of government spending in the GDP. Meanwhile, as the economies move from developing to developed, share of Government spending in GDP increases. 

With this analysis as a baseline, future work could be done to project growth in an economy based on its developmental stage and the specific activities of governments and central banks, as well as their particular economic stage. There are some additional provocative implications here concerning the ability of governments in developing economies to influence GDP – small details with a big impact on the global economic stage. 

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This article was first published on fischerjordan.com