Public debt, domestic and external financing, and economic growth

This paper examines the effect of public debt on growth by controlling for the institutional environment in which the debt was issued in countries grouped by income levels for the period of 1990 to 2007. Our analysis distinguishes between the growth impact of domestic versus external public debt to examine the importance of domestic financing as compared to external financing. In particular, the regressions? outcome points clearly in the direction of a non-linear relationship between total public debt and growth in the subsets of middle and low-income countries, and this relationship is mainly driven by the non-linear relationship that exists between public external debt and growth, and not by the domestic component of it. Otherwise stated, it appears that high levels of external public debt are associated with low per capita GDP growth rates, but that high levels of domestic public debt are not necessarily associated with low growth. We identify ranges of values for the optimal level of public debt (i. e. the level after which the marginal impact of further debt accumulation becomes harmful for growth) in middle and low-income countries. In a subset of high income countries, we did not find any support for a robust relationship between public debt and growth. Another noteworthy insight that emerges is a strong link between financial development and growth across a subset of middle-income countries. Our analysis shows that the debt structure is relevant to growth and highlights the importance of the development of the domestic bond markets to promote long-lasting economic growth.