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Does Public Debt Produce a Crowding Out Effect for Public Investment in the EU?

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  • Mattia Osvaldo Picarelli
  • Willem Vanlaer
  • Wim Marneffe

Abstract

This paper exploits a panel dataset for 26 EU countries, between 1995 and 2015, to examine the extent to which increased levels of public debt have led to reduced public investment, the so-called ‘debt overhang’ hypothesis. To address endogeneity concerns, we use an instrumental variable approach based on a GMM estimation. Our results validate the debt overhang hypothesis and remain robust across various estimation techniques. The GMM specification with year dummies indicates that a 1% increase in public debt in the EU brings about a reduction in public investment of 0.03%. Moreover, we find evidence that: 1) the results are mainly driven by high-debt countries; 2) the negative impact of debt on investment is slightly smaller in the Eurozone than in the entire EU; 3) both the stock and flow of public debt play a role in reducing public investment with the impact of the latter that is found to be more profound.

Suggested Citation

  • Mattia Osvaldo Picarelli & Willem Vanlaer & Wim Marneffe, 2019. "Does Public Debt Produce a Crowding Out Effect for Public Investment in the EU?," Working Papers 36, European Stability Mechanism.
    • Handle: RePEc:stm:wpaper:36
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    Cited by:

    1. Karsten Staehr & Katri Urke, 2022. "The European structural and investment funds and public investment in the EU countries," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 49(4), pages 1031-1062, November.
    2. Jan Willem van den End & Guido Schotten & Sophie Steins Bisschop, 2021. "Financing the transition: seizing opportunities for a green recovery," Occasional Studies 1902, DNB.
    3. Dobdinga Cletus Fonchamnyo & Gildas Dohba Dinga & Vahsegmi Carolle Ngum, 2021. "Revisiting the nexus between domestic investment, foreign direct investment and external debt in SSA countries: PMG‐ARDL approach," African Development Review, African Development Bank, vol. 33(3), pages 479-491, September.
    4. Willem Vanlaer & Mattia Picarelli & Wim Marneffe, 2021. "Debt and Private Investment: Does the EU Suffer from a Debt Overhang?," Open Economies Review, Springer, vol. 32(4), pages 789-820, September.
    5. Gigamon Joseph Prah & Charles Ofori, 2022. "External Debt and Foreign Investment: An Empirical Analysis on the Economy of Ghana," Eurasian Journal of Economics and Finance, Eurasian Publications, vol. 10(2), pages 54-67.

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    More about this item

    Keywords

    public investment; debt overhang; credit rationing;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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