The impact of high government debt on economic growth and its channels: An empirical investigation for the euro area

This paper investigates the average impact of government debt on per-capita GDP growth in twelve euro area countries over a period of about 40 years starting in 1970. It finds a non-linear impact of debt on growth with a turning point — beyond which the government debt-to-GDP ratio has a deleterious impact on long-term growth — at about 90-100% of GDP. Confidence intervals for the debt turning point suggest that the negative growth effect of high debt may start already from levels of around 70-80% of GDP, which calls for even more prudent indebtedness policies. At the same time, there is evidence that the annual change of the public debt ratio and the budget deficit-to-GDP ratio are negatively and linearly associated with per-capita GDP growth. The channels through which government debt (level or change) is found to have an impact on the economic growth rate are: (i) private saving; (ii) public investment; (iii) total factor productivity (TFP) and (iv) sovereign long-term nominal and real interest rates. From a policy perspective, the results provide additional arguments for debt reduction to support longer-term economic growth prospects.

https://www.econstor.eu/bitstream/10419/153671/1/ecbwp1237.pdf

The impact of high and growing government debt on economic growth: an empirical investigation for the euro area

This paper empirically explores the relationship between debt and growth for a number of developing and industrial economies For developing 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 the capital accumulation growth There is only limited evidence on the relationship between external debt and total factor productivity growth In addition, for private savings rates there are mixed results 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

/pdf/debt-and-economic-growth-in-developing-and-industrial-2oohwgrbrs.pdf

Debt and Economic Growth in Developing and Industrial Countries

The relationship between budget deficits and macroeconomic variables (such as growth, interest rates, trade deficit, exchange rate, among others) represents one of the most widely debated topics among economists and policy makers in both developed and developing countries. However, the purpose of this paper is to review the extensive literature to such a relationship, concentrating on theoretical debates and empirical studies, in order to derive substantive conclusions, which can be beneficial in the macroeconomics area; policy analysis; or in terms of constructing or developing a macroeconomic model for analyzing the impact of budget deficits on macroeconomic variables. The majority of these studies regress a macroeconomic variable on the deficit variable. These studies are cross-country and utilize time series data. In general the key outcomes from the studies presented in this paper indicated that both the method of financing and the components of government expenditures could have different effects. Therefore, it is crucial for the government to distinguish between consumption and investment expenditures especially when the government is in the process of evaluating the impact of fiscal policy on private investment and output growth or in the process of cutting expenditures to reduce the fiscal imbalances in the country. Even though the overall results from the empirical literature with respect to the impact of public investment on private investment and growth are ambiguous, the bulk of the empirical studies find a significantly negative effect of public consumption expenditure on growth, while the effects of public investment expenditure (such as on education, healthcare) are found to be positive although less robust. The key findings from these studies is important in particular for developing countries to be aware of the importance of government investment expenditures in the area of education, healthcare, infrastructure to long-term economic growth and the benefits from which are an important contributor to welfare and well-being. The key outcome from all of the studies presented in this paper while investigating the relationship between the budget deficit and current account deficit showed strong evidence in both developed and developing countries towards supporting the Keynesian proposition (conventional view) which suggests that an increase in the budget deficit would induce domestic absorption and, hence import expansion, causing a current account deficit. The key findings from the empirical studies investigating the relationship between the budget deficit and interest rates indicated strong evidence towards supporting the Keynesian model of a significant and positive relationship between budget deficits and interest rates. The major outcomes from the empirical studies examining the relationship between budget deficits and inflation showed strong evidence that the budget deficit financed through monetization and a rising money supply could lead to inflation.

/pdf/the-budget-deficit-and-economic-performance-a-survey-3qoxh2e4pk.pdf

The budget deficit and economic performance: A survey

The non-linear impact of high and growing government external debt on economic growth: A Markov Regime-switching approach

Kuznets's inverted-U hypothesis revisited

I. INTRODUCTION In recent years, federal deficits and debt have increased to phenomenal levels. In 1993, total debt reached $4.35 trillion, and the debt burden per capita amounted to $16,848. Measured in 1987 dollars, total debt and per capita debt were $3.5 trillion and $13,565, respectively. For a family of four, the debt burden was $54,260 in 1987 dollars.(1) Legislators have made several efforts, such as the Gramm-Rudman-Hollings (GRH) Act of 1986 and the Budget Reconciliation Bill of 1993, to reduce deficits and debt. But the former attempt has failed and the impact of the latter remains to be seen. Clearly almost all countries incur debt to provide adequate public services, finance the construction of infrastructures, and pursue full employment and economic growth. Federal debt may facilitate or deter economic growth, depending on the level of the debt. When economic growth is slow or when the private sector does not have incentives to invest, the federal government may need to pursue fiscal and/or monetary policy to stimulate the economy and may resort to debt financing. On the other hand, when economic growth is normal or above the long-term trend, an increase in federal government debt may be detrimental to real GDP growth. This is because an increase in federal debt may push interest rates upward and reduce private investment. The three views of the impact of federal deficits and debt on economic growth more clearly explain these arguments. (For a detailed analysis of these three views, see Sawhney and Di-Pietro, 1994.) The stimulus view (Eisner, 1984) argues that if deficits and debt are measured correctly, higher deficits and debt will stimulate employment, consumption, investment, and economic growth. The crowding-out view (Friedman, 1988) maintains that higher deficits and debt will reduce economic growth due to rising interest rates and lower investment and capital formation. The Ricardian view (Barro, 1989) holds that deficits and debt do not have any impacts on economic growth because the decrease in future income and consumption due to more tax burdens will offset the increase in current government spending. Because these hypotheses represent different relations, a quadratic form is an appropriate way to test the positive, horizontal, and negative relations. This paper extends the work of Barro (1979), Eisner (1992), Joines (1991) and others to examine the federal government debt's impact on economic growth and to test if an optimal debt ratio exists that will maximize the economic growth rate.(2) Barro (1979, p. 966) argues that his "result supports the surprising proposition of the theory that the debt/income ratio does not have a 'target' value but rather moves 'randomly' in accordance with the realizations for the federal expenditure and income shock." Few studies demonstrate that this may not be the case. A number of studies (Eisner, 1992; Joines, 1991) choose different debt/GDP ratios so that the debt would not grow faster than the GDP or so that the debt is within a reasonable range. However, they do not test if these debt/GDP ratios are optimal. II. LITERATURE SURVEY Deficits and debt and their relationships with other macroeconomic variables have been investigated extensively. Eisner (1992) is optimistic about the deficit and debt issue. After adjusting for deposit insurance, net investment, state and local budgets, and inflation tax, he estimates that the deficit in 1991 would be a very small amount of $17 billion rather than the reported value of $269 billion. He indicates that a constant debt/GDP ratio may be maintained so that the debt does not grow faster than the GDP. He chooses a constant public debt/GDP ratio of 47.1 percent as the one that corresponds to a deficit of $188 billion. However, he does not indicate whether this 47.1 percent is the optimal debt ratio. Joines (1991) selects three public debt ratios for comparison and regards the 40 percent debt ratio as the long-run historical average. …

In search of an optimal debt ratio for economic growth

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Kuznets's inverted-U hypothesis revisited

In search of an optimal debt ratio for economic growth