Posted

September 09, 2010 12:02:39 AM

Date

2010-08

Author

Cristina Checherita Philipp Rother

Affiliation

European Central Bank

Title

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

Summary /
Abstract

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.

Keywords

Public debt, economic growth, fiscal policy, sovereign long-term interest rates

URL

http://d.repec.org/n?u=RePEc:ecb:ecbwps:20101237&r=fdg

Remarks

For the euro area, the ECB authors find that the negative growth effects of total (domestic and external) government debt begin from about 70-80 percent of GDP. Given that the domestic debt component accounts for around 30 percent of GDP on average, the threshold for the external debt component is in the range of 40-50 percent of GDP. In the case of the emerging market economies, I estimated the optimal (Ramsey) gross foreign debt (government plus private) in the range of 37-52 percent of GDP (Ch. 3, Macroeconomic Policies for Stable Growth (World Scientific, 2008)). The Philippine external debt ratio has been falling from 62.7 percent in 2004 to 38.8 percent of GDP in 2008. At the end of 2008, the public external debt ratio stood at 35.4 percent of GDP. The IMF projects this ratio to decline to 32.3 percent of GDP in 2011 and further to 29.3 percent of GDP by 2014. Adding the private foreign debt component to these projections would place the total Philippine foreign debt ratio in the lower limit of the optimal range.

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