Public debt and growth: Heterogeneity and non-linearity

Markus Eberhardt and Andrea F. Presbitero

The relationship between public debt and economic growth has recently emerged once again as a hotly debated topic in academia and among policymakers. Starting from the seminal contribution of Carmen Reinhart and Kenneth Rogoff (2010) a large strand of literature has investigated this relationship, attempting to identify possible non-linearities (thresholds in the debt-growth nexus) and discussing to what extent debt accumulation has a detrimental and causal effect on GDP growth. The UK and US governments are among those to have cited Carmen Reinhart and Kenneth Rogoff's work (the infamous 90% debt-to-GDP threshold) to help justify continued austerity measures.

In this Nottingham School of Economics working paper, recently published in The Journal of International Economics, Markus Eberhardt and his co-author Andrea F. Presbitero adopt a number of recent methods from the panel time series literature which have significant bearings on how the debt-growth nexus can be modelled empirically: methods allow studying (1) whether a negative long-run relationship between public debt and growth exists and whether this relationship differs substantially across countries; (2) whether within individual countries there is any evidence for thresholds or 'high vulnerability regions' where this relationship may change from a positive significant or insignificant to a significant negative one. Using total public debt data from 118 economies for 1960-2012 the study finds that in the long-run the relationship between public and growth differs across countries and that countries with higher average debt-to-GDP ratios on balance are more likely to see a negative effect on their long-run growth performance. However, the debt-growth nexus differs significantly across countries and modelling non-linearities within countries does not show the emergence of any common pattern. These findings imply that whatever the shape and form of the debt-growth relationship, it differs across countries, so that appropriate policies for one country may be seriously misguided in another.

Forthcoming The Journal of International Economics, “Public debt and growth: Heterogeneity and non-linearity” by Markus Eberhardt and Andrea F. Presbitero

http://dx.doi.org/10.1016/j.jinteco.2015.04.005

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