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Public Debt and Economic Growth Conundrum: Nonlinearity and Inter-temporal Relationship

The influential paper by Reinhart and Rogoff (2010) has triggered a debate about the effects of the public debt on economic growth rates. They argue that a debt-to-GDP ratio of 90 percent or greater has a deleterious effect on long run economic growth. Subsequent papers provide more convincing results. In this paper, we examine the inter-temporal relationship between public debt and GDP growth rates. First, we examine debt-to-GDP thresholds in nonlinear panel models, using various econometric strategies, methodologies, and ample data samples. We also evaluate confidence intervals around the estimated thresholds to determine the accuracy of thresholds in the extant literature. Our results demonstrate that in a majority of estimated models, threshold values are not uniquely defined and the estimated coefficients are insignificant in most model specifications, as indicated in Enders et al. (2007). Next, we formally examine the inter-temporal relationship between the public debt and economic growth using structural panel data models as well as reduced form panel VAR models with three different data sets. In contrast to the standard presumption in the literature, we find that the inter- temporal effect of economic growth on the public debt is strong, but the effect of the public debt on economic growth is weak. We find similar results in sub-samples that include only countries where the public debt is greater than 90 percent of GDP. We also provide policy implications.

Economic Growth, Public Debt, Panel Data Model, Feedback Effect, Threshold

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