Public Debt Overhangs: Advanced-Economy Episodes Since 1800

Abstract

T The recent fi nancial crisis and recession has left a legacy of historically high he recent fi nancial crisis and recession has left a legacy of historically high and rising level of public indebtedness across the advanced economies. and rising level of public indebtedness across the advanced economies. The central policy debate across Europe, Japan, and the United States now The central policy debate across Europe, Japan, and the United States now centers on how fast to stabilize soaring public debt/GDP ratios, given that post-crisis centers on how fast to stabilize soaring public debt/GDP ratios, given that post-crisis growth remains fragile. We bring evidence to bear on the issue by identifying the growth remains fragile. We bring evidence to bear on the issue by identifying the major public debt overhang episodes in advanced economies since the early 1800s. major public debt overhang episodes in advanced economies since the early 1800s. Following Reinhart and Rogoff (2010), we select stretches where gross public debt Following Reinhart and Rogoff (2010), we select stretches where gross public debt exceeds 90 percent of nominal GDP on a sustained basis. Such public debt overhang exceeds 90 percent of nominal GDP on a sustained basis. Such public debt overhang episodes are associated with lower growth than during other periods. Even more episodes are associated with lower growth than during other periods. Even more striking, among the 26 episodes we identify, 20 lasted more than a decade. The long striking, among the 26 episodes we identify, 20 lasted more than a decade. The long duration belies the view that the correlation is caused mainly by debt buildups during duration belies the view that the correlation is caused mainly by debt buildups during business cycle recessions. The long duration also implies that the cumulative shortfall business cycle recessions. The long duration also implies that the cumulative shortfall in output from debt overhang is potentially massive. These growth-reducing effects of in output from debt overhang is potentially massive. These growth-reducing effects of high public debt are apparently not transmitted exclusively through high real interest high public debt are apparently not transmitted exclusively through high real interest rates, in that in eleven of the episodes, interest rates are not materially higher. rates, in that in eleven of the episodes, interest rates are not materially higher.

Does Government Debt Affect Bank Credit?

“…Choosing a threshold of 90% of the debt-to-GDP ratio, Reinhart et al (2012) identify 26 episodes of public debt overhangs in advanced countries since 1800. But only six of these episodes -involving Japan, Belgium, Canada, Ireland, Greece and Italytook place after 1970.…”

What happens to the relationship between public debt and economic growth in European countries?

“…On the one hand, authors such as Reinhart and Rogoff (2010), Cecchetti, et al (2011), Reinhart et al (2012, Checherita-Westphal and Rother (2012), Baum et al (2013), Mencinger et al (2014) and Woo and Kumar (2015) show the existence of a negative impact of debt on economic growth once a "magic threshold of debt"/turning point is reached and "debt intolerance" 4 appears. On the other hand, Panizza and Presbitero (2014) do not find that public debt causes economic growth and they conclude that there is no evidence that high levels of public debt have a negative impact on economic growth in the medium-term for advanced economies.…”

“…Reinhart et al (2012) and Panizza and Presbitero (2013) for surveys on this issue. 4 See Reinhart et al (2003).…”

Nonlinearities in the Relationship Between Debt and Growth: (No) Evidence From Over Two Centuries

“…Although recent revelations challenged the descriptive analysis carried out in their paper, Reinhart and Rogoff maintain that "the weight of the evidence to date -including this latest comment [by Herndon, Ash and Pollin, 2014] -seems entirely consistent with our original interpretation of the data" (Wall Street Journal 'Real Time Economics' blog, April 16, 2013), namely that "high debt/GDP levels (90 percent and above) are associated with notably lower growth outcomes" (Reinhart and Rogoff, 2010b: 577; see also Rogoff, 2013). Perhaps aware of the tension between the causal interpretation typically read into this type of statement and the descriptive nature of their analysis, some of their earlier work (Reinhart, Reinhart and Rogoff, 2012) already pointed to a set of empirical studies which are argued to address both concerns regarding causality and identification of a nonlinearity in the long-run debt-growth relationship (e.g. Kumar This paper investigates the debt-growth nexus from a new angle and with a somewhat more modest aim, focusing on the persistence of the long time series data used in the original Reinhart and Rogoff (2010b) study.…”