Public debt and macroeconomic activity: a predictive analysis for advanced economies

Using post-war data on advanced economies, we find that a higher public debt ratio predicts marginally slower GDP growth under the assumption of a linear relationship. This result is robust to strong persistence in debt ratio, which may cause finite sample bias in estimation and inference. In the nonlinear framework, we find only weak support for piece-wise linear models that explicitly incorporate the idea of a debt tipping point. The threshold estimates from such models are subject to a high level of uncertainty and are sensitive to assumptions on minimum number of observations in each regime. However, using a flexible semiparametric model we uncover that the predictive function is highly complex and behaves quite differently at low, intermediate and high levels of debt. Of particular interest to the recent debate on effects of higher public indebtedness on growth, we find that average annual GDP growth gradually declines by about 0.5% as debt ratio climbs from about 75% to 100%, with most of the effect taking place over the 85–95% range.