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Finding the tipping point -- when sovereign debt turns bad

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  • Caner, Mehmet
  • Grennes,Thomas
  • Koehler-Geib, Fritzi

Abstract

Public debt has surged during the current global economic crisis and is expected to increase further. This development has raised concerns whether public debt is starting to hit levels where it might negatively affect economic growth. Does such a tipping point in public debt exist? How severe would the impact of public debt be on growth beyond this threshold? What happens if debt stays above this threshold for an extended period of time? The present study addresses these questions with the help of threshold estimations based on a yearly dataset of 101 developing and developed economies spanning a time period from 1980 to 2008. The estimations establish a threshold of 77 percent public debt-to-GDP ratio. If debt is above this threshold, each additional percentage point of debt costs 0.017 percentage points of annual real growth. The effect is even more pronounced in emerging markets where the threshold is 64 percent debt-to-GDP ratio. In these countries, the loss in annual real growth with each additional percentage point in public debt amounts to 0.02 percentage points. The cumulative effect on real GDP could be substantial. Importantly, the estimations control for other variables that might impact growth, such as the initial level of per-capita-GDP.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 5391.

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Date of creation: 01 Jul 2010
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Handle: RePEc:wbk:wbrwps:5391

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Related research

Keywords: External Debt; Economic Theory&Research; Debt Markets; Emerging Markets; Public Sector Economics;

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References

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  1. Reinhart, Carmen & Rogoff, Kenneth & Savastano, Miguel, 2003. "Debt intolerance," MPRA Paper 13932, University Library of Munich, Germany.
  2. Acemoglu, Daron & Johnson, Simon & Robinson, James A & Thaicharoen, Yunyong, 2002. "Institutional Causes, Macroeconomic Symptoms: Volatility, Crises and Growth," CEPR Discussion Papers 3575, C.E.P.R. Discussion Papers.
  3. 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.
  4. Catao, Luis A.V. & Terrones, Marco E., 2005. "Fiscal deficits and inflation," Journal of Monetary Economics, Elsevier, vol. 52(3), pages 529-554, April.
  5. Hélène Poirson & Luca Antonio Ricci & Catherine A. Pattillo, 2002. "External Debt and Growth," IMF Working Papers 02/69, International Monetary Fund.
  6. Reinhart, Carmen & Rogoff, Kenneth, 2010. "Growth in a Time of Debt," CEPR Discussion Papers 7661, C.E.P.R. Discussion Papers.
  7. Laura Alfaro & Sebnem Kalemli-Ozcan, 2004. "Why doesn't capital flow from rich to poor countries? An empirical investigation," 2004 Meeting Papers 53, Society for Economic Dynamics.
  8. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  9. Tito Cordella & Luca Antonio Ricci & Marta Ruiz-Arranz, 2005. "Debt Overhang or Debt Irrelevance? Revisiting the Debt Growth Link," IMF Working Papers 05/223, International Monetary Fund.
  10. Hélène Poirson & Luca Antonio Ricci & Catherine A. Pattillo, 2004. "What Are the Channels Through Which External Debt Affects Growth?," IMF Working Papers 04/15, International Monetary Fund.
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Cited by:
  1. Andrea F. Presbitero, 2010. "Total Public Debt and Growth in Developing Countries," Development Working Papers 300, Centro Studi Luca d\'Agliano, University of Milano.
  2. Michele Fratianni, 2011. "Riflessioni sulla politica economica italiana in occasione del 150esimo anniversario dell'Unita'," Mo.Fi.R. Working Papers 53, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
  3. Michele Fratianni & Antonio Maria Rinaldi & Paolo Savona, 2013. "Una proposta per ridurre il fardello del debito pubblico italiano," Mo.Fi.R. Working Papers 81, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.

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