Unravelling the EU Debt Knot Over 2000-2019: An Injection-Leakage Approach

Against the backdrop of a negative relation between the public debt and the economic growth in the EU over 2000-2019, the government budget constraint could clearly outline the transmission channels at work. Firstly, the debt stock weakens the fiscal policy of the government. It is emphasized that a debt stock surpassing 100% of GDP is critical for any government as it renders the budget impulses incapable to generate at least a proportional change in GDP. This conclusion is further strengthened by the proposed decomposition of the expenditure multiplier into several terms. They unambiguously reveal that its value is negatively affected by the budget surplus, the debt ratio’s growth rate and the output gap. Secondly, the effects of the public indebtedness are tracked down to the overall economy. Initially, the private sector’s cyclical behaviour is found to weaken the higher the average debt position of a country which accounts for the lower economic growth in a high debt environment. Eventually, the nonlinear relationship between the debt ratio and the net private savings is explored by estimating a TAR model for each EU country over 2002-2019. It is inferred that while in the first regimes, the injections and leakages take turns, in the second regimes, the leakages exceed the injections. Furthermore, it is concluded that the higher the debt ratio, the greater the number of regimes a country might fall into and the greater the number of the autoregressive terms suggesting a persistent change in the private agents’ behaviour.