Heterogeneity in the debt-growth nexus: Evidence from EMU countries

Abstract

The objective of this paper is to examine whether the threshold beyond which a public debt change may have a detrimental effect on economic growth changes across euro area countries during the 1961-2015 period. In contrast with previous studies, we do not use panel estimation techniques, but implement a time-series analysis for each country based on the growth literature. The results suggest that in all the countries but Belgium a debt increase begins to have detrimental effects on growth well before the SGP debt ceiling (a debt ratio of around 40% and 50% in central and peripheral countries, respectively) is reached. So, although austerity policies should be applied in EMU countries-since according to our results debt reduction barely exerts any significant beneficial impact on EMU countries' growth-they should be accompanied by structural reforms that can increase their potential GDP. Moreover, as our results suggest that the harmful impact of a debt change on growth does not occur beyond the same threshold and with the same intensity in all EMU countries, a focus on average ratios and impacts may be unsuitable for defining policies. Specifically, our findings suggest that the pace of fiscal adjustment should be lower in Greece and Spain than in the other countries.

The Heterogeneous Public Debt–Growth Relationship: The Role of the Expenditure Multiplier

“…The estimates on control variables are mainly consistent with findings in previous research [4,7,8,[44][45][46][47][48] and in line with economic theory. Estimates show that countries are converging since 1 percent higher per capita GDP is associated with 0.06-0.12 percentage points slower growth and vice versa.…”

“…Similar relationships show estimates with annual growth rate and tenyear average growth rate which are presented in Appendices B and C. However, as regards control variables, some differences can also be observed compared to the results of other researchers. The negative effect of trade openness is observed in countries with weak institutions [8,44,45]; other studies find a positive impact of population growth [7,8,48].…”

“…The estimated debt turning points should be considered with caution. Eberhardt and Presbitero [52], Gómez-Puig and Sosvilla-Rivero [48,53], Ahlborn and Schweickert [7] suggest that it is worthless to look for a debt threshold that holds for all countries (or country groups). Eberhardt and Presbitero [52] indicate that a country's ability to increase the debt level without facing a slowdown effect on the economy may depend the on various country-specific factors.…”

Role of Uncertainty in Debt-Growth Nexus

“…Our model for examining the mediating effect of uncertainty on the debt-growth nexus is based on the neoclassical growth equation and consistent with specifications previously used to analyse the sources of heterogeneity in the debt-growth relationship (Panizza and Presbitero, 2013;Eberhart andPresbitero, 2015, Ahlborn andSchweickert, 2016;Gómez-Puig and Sosvilla-Rivero, 2017;Chiu and Lee, 2017;Law et al, 2021). Assuming that the debt effect on growth remains constant irrespective of debt values (i.e., the debtgrowth relationship is linear), the neoclassical growth equation for the panel data takes the following form: + ∆ stands for the 5-year forward-looking (t → t + 5) average per capita GDP growth rate in the country i, Y i,t is the per capita GDP at constant prices in the initial period t, GE i,t is the World Bank's (WB) estimate of government effectiveness used to proxy effective governance, G i,t stands for the government size in the economy, S i,t is the secondary school enrolment used to proxy human capital, ΔlnPOP i,t is the population growth and ΔlnCPI i,t is the change in the consumer price index used to proxy inflation, proxy the capital investment rate and T i,t trade openness, D i,t is the public debt-to-GDP ratio (a more detailed explanation of the variables is provided in Table 1).…”

Permanent and transitory effect of public debt on economic growth

“…where Z is a vector of control variables that includes inflation, trade openness and population growth (Baum et al, 2013;Mohamed, 2013;Daud and Podivinsky, 2014;Fincke and Greiner, 2015;Baharumshah et al, 2017;Bal and Rath, 2017;G omez-Puig and Sosvilla-Rivero, 2017;Fofana, 2018), and ε is the white noise error term.…”