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

Abstract

Currently countries are facing a new crisis caused by the COVID-19, which leads to the rise of government expenditures and additional borrowing. This situation highlights the importance of examine factors which determine the level of public debt that still sustains economic growth. A growing body of research supports the idea of a non-linear debt–growth relationship and estimates the threshold level above which debt becomes unsustainable and has a negative effect on output. The empirical evidence points out that there is no single sustainable debt threshold level that holds for all countries. This research complements scarce empirical evidence on the heterogeneous debt–growth relationship and provides some insights on the publicly available statistical indicators that might signal a relatively low/high expenditure multiplier and, at the same time, potentially unsustainable/sustainable growth stimulus through the use of borrowed funds. We test the hypothesis that the expenditure multiplier is shaping the impact of public debt on growth. Our empirical examination is based on panel data analysis in the groups of countries with expected relatively high and low expenditure multiplier. Research results show that a statistically significant negative marginal effect of debt on growth starts to manifest at a lower debt-to-GDP ratio when the expenditure multiplier is lower and vice-versa. The study shed some light on the sources of heterogeneity in a debt–growth relationship. We can conclude that countries with a high expenditure multiplier level can borrow more and sustain growth. In contrast, in countries with a lower expenditure multiplier, a relatively low debt level becomes unsustainable for growth.

The Relationship between Government Debt and Social Welfare

“…Empirical result from Tables 5 found that statistically in the short-run the additional debt-to-GDP had no significant effect on GDP per capita in Indonesia, while in the long-run it had a significant effect on GDP per capita. This findings are also found in study by Butkus et al (2015); and Spilioti (2015). study them stated that debt-to-GDP has an impact on GDP per capita, this study using the additional debt-to-GDP variable, the findings of equation ( 2) also looks at the short and long-run effects from the population, tax-to-GDP, and inflation variables.…”

Empirical Evidence on Factors Conditioning the Turning Point of the Public Debt–Growth Relationship

“…However, the significance of the estimated coefficients is weak. The explanation may be that the debt-growth relationship depends on a multiplier (Butkus et al 2021), but no single factor determining the multiplier can lead to significantly different effects of debt on economic growth.…”

“…There has been extensive debate in the literature on the question of how public debt affects the size of the fiscal multiplier. Numerous pieces of empirical evidence suggest an inverse relationship between these two variables (see, for review, Butkus et al 2021). However, Huidrom et al (2020) point to the lack of a systematic study on the channels through which public debt affects the fiscal multiplier.…”

“…This paper contributes to the limited literature on the factors conditioning the turning point of the public debt-growth relationship. Butkus et al (2021) relate the debt threshold with the size of the expenditure multiplier. According to Keynesian theory, a higher expenditure multiplier leads to a higher positive impact of government expenditure (an increase in public debt) on domestic demand and GDP growth.…”

“…If conditions necessary for a higher multiplier value are met, namely higher propensities to consume and invest, lower propensity to import, and a lower tax rate, then countries may expect to sustain growth with higher debt-to-GDP ratios. Butkus et al (2021) estimated higher debt threshold levels for countries with higher ratios of private consumption and investment to GDP, as well as lower ratios of imports and taxes to GDP. This paper complements the results of the aforementioned study and aims to estimate the thresholds of indicators on which the expenditure multiplier depends, which may already imply a risk that public debt will dampen economic growth.…”