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Debt and growth: new evidence for the euro area

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  • Baum, Anja
  • Checherita-Westphal, Cristina
  • Rother, Philipp

Abstract

Against the background of the euro area sovereign debt crisis, our paper investigates the relationship between public debt and economic growth and adds to the existing literature in the following ways. First, we extend the threshold panel methodology by Hansen (1999) to a dynamic setting in order to analyse the nonlinear impact of public debt on GDP growth. Second, we focus on 12 euro area countries for the period 1990-2010, therefore adding to the current discussion on debt sustainability in the euro area. Our empirical results suggest that the shortrun impact of debt on GDP growth is positive and highly statistically significant, but decreases to around zero and loses significance beyond public debt-to-GDP ratios of around 67%. This result is robust throughout most of our specifications, in the dynamic and non-dynamic threshold models alike. For high debt-to-GDP ratios (above 95%), additional debt has a negative impact on economic activity. Furthermore, we can show that the long-term interest rate is subject to increased pressure when the public debt-to-GDP ratio is above 70%, broadly supporting the above findings. JEL Classification: H63, O40, E62, C20

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1450.

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Date of creation: Jul 2012
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Handle: RePEc:ecb:ecbwps:20121450

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Keywords: Economic Growth; Fiscal Policy; public debt; threshold analysis;

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  1. Lorenzo Codogno & Carlo Favero & Alessandro Missale, 2003. "Yield spreads on EMU government bonds," Economic Policy, CEPR & CES & MSH, vol. 18(37), pages 503-532, October.
  2. Jacopo Cimadomo, 2012. "Fiscal Policy in Real Time," Scandinavian Journal of Economics, Wiley Blackwell, vol. 114(2), pages 440-465, 06.
  3. Schuknecht, Ludger & von Hagen, Jürgen & Wolswijk, Guido, 2009. "Government Bond Risk Premiums in the EU revisited: The Impact of the Financial Crisis," CEPR Discussion Papers 7499, C.E.P.R. Discussion Papers.
  4. Bruce E. Hansen, 1997. "Threshold effects in non-dynamic panels: Estimation, testing and inference," Boston College Working Papers in Economics 365, Boston College Department of Economics.
  5. Stephanie Kremer & Alexander Bick & Dieter Nautz, 2009. "Inflation and Growth: New Evidence From a Dynamic Panel Threshold Analysis," SFB 649 Discussion Papers SFB649DP2009-036, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  6. M Arellano & O Bover, 1990. "Another Look at the Instrumental Variable Estimation of Error-Components Models," CEP Discussion Papers dp0007, Centre for Economic Performance, LSE.
  7. Caselli, Francesco & Esquivel, Gerardo & Lefort, Fernando, 1996. " Reopening the Convergence Debate: A New Look at Cross-Country Growth Empirics," Journal of Economic Growth, Springer, vol. 1(3), pages 363-89, September.
  8. Carmen M. Reinhart & Kenneth S. Rogoff, 2010. "Growth in a Time of Debt," American Economic Review, American Economic Association, vol. 100(2), pages 573-78, May.
  9. Schclarek, Alfredo, 2004. "Debt and Economic Growth in Developing and Industrial Countries," Working Papers 2005:34, Lund University, Department of Economics.
  10. Kazuhiko Hayakawa, 2009. "First Difference or Forward Orthogonal Deviation- Which Transformation Should be Used in Dynamic Panel Data Models?: A Simulation Study," Economics Bulletin, AccessEcon, vol. 29(3), pages 2008-2017.
  11. Caner, Mehmet & Hansen, Bruce E., 2004. "Instrumental Variable Estimation Of A Threshold Model," Econometric Theory, Cambridge University Press, vol. 20(05), pages 813-843, October.
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