Public debt, growth, and threshold effects: A comparative analysis based on income categories

Whether or not public debt stifles economic growth remains a relevant research question. An equally relevant follow-up question is whether there is a certain threshold, applicable to all countries, above which debt becomes a drag on growth. Although there is generally no consensus, researchers seem to agree that the relationship between debt and growth is, at best, heterogenous across countries and groups. This study is motivated by the idea of parameter heterogeneity according to which the data generating process that characterizes each country’s growth process is not the same for all observations. Although previous studies have focused more on the asymmetric effect of debt on growth above and below a particular debt threshold, evidence shows that the level of debt is not the only plausible threshold variable. This study examines the influence of income per capita and countries’ historical categorization by income on the debt-growth nexus. It also examines the variation in the nexus across low, lower-middle, upper-middle, and high-income countries. Mainly, the study presents a debt threshold value of around 45% for all countries beyond which debt impacts negatively on growth. It also finds that the relationship between debt and growth varies considerably from one income group to another. Notably, the threshold of debt tends to rise as one moves up from low to high-income category. Given the negative relationship between debt and growth above the threshold, it is important for countries, particularly those in the lower income categories, to exercise some caution in the accumulation of debt.