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Financial stress, sovereign debt and economic activity in industrialized countries: Evidence from dynamic threshold regressions

  • Proaño, Christian R.
  • Schoder, Christian
  • Semmler, Willi

We analyze how the impact of a change in the sovereign debt-to-GDP ratio on economic growth depends on the level of debt, the stress level on the financial market and the membership in a monetary union. A dynamic growth model is put forward demonstrating that debt affects macroeconomic activity in a non-linear manner due to amplifications from the financial sector. Employing dynamic country-specific and dynamic panel threshold regression methods, we study the non-linear relation between the growth rate and the debt-to-GDP ratio using quarterly data for sixteen industrialized countries for the period 1981Q1-2013Q2. We find that the debt-to-GDP ratio has impaired economic growth primarily during times of high financial stress and only for countries of the European Monetary Union and not for the stand-alone countries in our sample. A high debt-to-GDP ratio by itself does not seem to necessarily negatively affect growth if financial markets are calm.

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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 45 (2014)
Issue (Month): C ()
Pages: 17-37

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Handle: RePEc:eee:jimfin:v:45:y:2014:i:c:p:17-37
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