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Government Debt and Growth: The Role of Liquidity

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  • Mathieu Grobéty

Abstract

How does government debt affect long-run economic growth? A prominent strand of theoretical literature suggests that government debt has a negative effect on growth. Another strand argues that government debt can foster growth by enhancing the supply of liquid assets or collateral. We empirically investigate the liquidity channel of government debt and apply the difference-in-differences methodology of Rajan and Zingales (1998) on a sample of 28 manufacturing industries across 39 developing and developed countries. We provide evidence that industries with greater liquidity needs tend to grow disproportionately faster in countries with higher levels of government debt. The positive liquidity effect of government debt on industry growth stems from domestic debt, not external debt. We perform a battery of robustness checks and show that our results are robust to using instrumental variables and controlling for many competing channels.

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  • Mathieu Grobéty, 2017. "Government Debt and Growth: The Role of Liquidity," Working Papers 2017-13, Swiss National Bank.
  • Handle: RePEc:snb:snbwpa:2017-13
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    Keywords

    Government Debt; Growth; Liquidity; Non-linearity;

    JEL classification:

    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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